CALSS 12 (CHAPTER 12 :''INTERNATIONAL TRADE'')ECONOMICS NOTES
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CHAPTER 12:
INTERNATIONAL TRADE
Introduction:
International Trade is the transaction of goods and
services between different countries. It is taken as a major part of
macroeconomics where various kinds of goods and services are exported and
imported among countries in the world. In International Trade nations or people
specialize in producing goods in which they have a greater comparative
advantage.
According to G. Lucket ‘The purchasing of goods and
services by the citizens of one country from the citizens of another country is
called International Trade’
International Trade has two aspects as Bilateral
International Trade where only two countries participate in transacting
commodities between each other and Multilateral International Trade where more
than two countries are involved in export and import of goods and services.
BALANCE OF TRADE
(BOT):
It is the summary of total volume of exports and
imports of visible goods and services of a country with the rest of the
countries in the world. Visible goods are those goods which are duly recorded
at custom barriers of the country. Balance of Trade has three scenarios:
a. Favourable or
Surplus BOT (Export > Import)
b. Deficit or
Unfavourable or Adverse BOT (Export < Import)
c. Balanced BOT
(Export = Import)
BALANCE OF
PAYMENT (BOP):
It is the sum of all transactions that take place
between its residents and residents of all foreign countries in the world. It
includes the transaction of visible and invisible items. Invisible items are
those goods and services which are not recorded in custom barriers. Balance of Payment
also has three scenarios:
a. Balanced or Equilibrium BOP (Receipts = Payments)
b. Surplus or Favourable BOP (Receipts >
Payments)
c. Deficit BOP (Receipts < Payments)
FREE TRADE:
The concept of freed trade was developed by
classical economists Adam Smith, Ricardo and others. Free Trade is the
international exchange of goods and services without any restrictions or
barrier. Under free trade policy, all kinds of artificial controls on
international trade such as tariffs, quotas etc are absent. There is no
distinction between internal and external trade and so it is also known as
Laissez Faire Policy in which there is no government’s unnecessary intervention
in foreign trade. Under this trade system, government does not impose tariff
and non-tariff barriers.
ADVANTAGES OF
FREE TRADE:
1. Optimum
Utilization of Resources: Under free trade policy, every
country specializes in the production of those goods and services in which it
has maximum profit. Therefore, every country devotes itself to produce those goods
by using the resources fully and efficiently.
2.Maximum
Profit:Due to free trade policy, a country specializes in
the production of those commodities which maximize the comparative profit. As a
result, productive capacity increases and the country can produce more goods
and services.
3.Benefit to
Consumers:Since every country produces only those goods that
can be produced at least cost in good quality, traders in other countries
import such goods and make these available to consumers at cheaper prices.
4.Benefit to
Producers/Market Expansion:International trade widens the
market for producers from domestic to international region. They can earn more
profit because of market expansion.
5.Technological
Improvement:In order to trade and compete in international
market producers are compelled to produce quality goods at minimum cost using
modern and cost reducing technology. This changes and improves every country to
endeavour to bring technological improvement and economizes cost and enhances
quality.
6.Creates
International Relation:Due to free trade policy, it makes
goods relation among trading partners and creates cooperative environment
between countries in the world.
DISADVANTAGES OF
FREE TRADE:
1. Dominates
Infant Industries:One of the major disadvantages of free
trade is that it dominates infant industries i.e. new industries of developing
countries which cannot compete with industries of developed countries in terms
of price, quality and quantity.
2.Unhealthy
Competition:In free trade, each and every country is
encouraged to increase export and there is excessive competition in production
and sales. It invites unhealthy competition among countries.
3.Creates
Dependency:Due to imbalanced industrial development
in the economy, it increases dependency of developing countries on developed
countries and ultimately reduces economic development.
4.Trade of
Harmful Products:Under free trade policy commodities are
freely exported and imported. There may be high chance to trade socially
restricted or injurious goods in order to earn more profit by business sector.
PROTECTION TRADE
OR PROTECTIONSIM:
Protectionism is that kind of trade policy where
home industries are encouraged by providing facilities for export and a number
of restrictions are imposed on import. The term Protection refers to policy of
encouraging home industries by giving subsidies to home products and imposing
duties on foreign goods by raising their prices relative to those of
domestically produced goods.
According to Mercantilist J. L. Hanson ‘Protection
means the imposition of duties on imports in order to protect home producers of
these commodities by making foreign produced goods and exempting native goods
of a similar character with the intension of preventing the market of the country
concerned’
Under Protection trade policy, two types of
instruments are used to protect domestic industries and they are: Tariff
barriers where government imposes high custom duties on imported goods to make
them relatively more expensive than domestic products and Non Tariff barriers
where government controls import by giving subsidy in domestic products by
applying quota system and others.
ADVANTAGES OF
PROTECTION TRADE:
1. Development
of Infant Industries: Infant industries need protection
to be able to stand in competition against grown up industries of advanced
countries. Therefore, infant industries in a country must be given protection
against foreign competition which helps for significant development of such
industries.
2.Development of
Basic and Large Scale Industries:In protection trade
policy, imports of foreign goods are controlled by government and domestic
producers are compelled to produce those goods. This helps to develop basic and
large scale industries.
3.Proper
Utilization of Resources:Domestic producers should produce
most of the necessary goods under this trade policy. Therefore, existing
resources are fully and efficiently utilized to fulfill the demand of domestic
countries.
4.Creates
Employment Opportunities:When industries are granted
protection, they expand and progress. New industries come up rapidly and new
opportunities for gainful employment are widely opened.
5.Self
Sufficiency:Due to protection trade policy,
producers of the countries produce almost all types of goods and services. It
increases self sufficiency and country becomes economically independent.
6.Reduces Supply
of Domestic Currency:Under this trade policy if imports are
controlled and people spend their money on domestically produced goods then
they get goods and also retain money at home.
DISADVANTAGES OF
PROTECTION TRADE:
1. Creation of
Monopolies:Due to protection trade policy, there is
not any kind of competition in domestic market. As a result, it consolidates
home industries to make monopoly power in the economy. Domestic Industries
control price and quantity to earn more profit.
2.Loss to
Consumers:Due to protection trade policy the price of domestic
goods is high. The consumers have to pay higher prices for such goods. They
should purchase domestic products whatever may be its price, quality and
others.
3.Decrease in
Competitive Capacity:Under protection trade policy the
protected industry becomes dependent on government and its policy. They cannot
develop their competitive capacity in terms of price, quality and quantity with
other countries goods.
4.Reduces
Foreign Relation:Protection may reduce relation between
various countries in international market.
COMPARATIVE COST
THEORY O F INTERNATIONAL TRADE
The concept of Comparative Cost Theory was developed
by famous classical economist David Ricardo. According to Ricardo the
international trade of export and import should be traded between two countries
on the basis of comparative cost differences. A Country A should produce that
commodity in which it has comparatively more advantage and Country B should
produce that commodity in which it has comparatively least disadvantage. It
will help both countries to manage international trade in best possible manner.
Ricardian concept of Comparative Cost Theory of International
Trade can be represented by following schedule:
The table clearly shows that Country A is quite
gainer in production of both commodities whereas B is loser in both
commodities. However, A has more comparative advantage in production of wheat
as it can manage to produce 8 times more output in comparison to B. Similarly,
Country B has minimum possible disadvantage in production of rice as it can
manage to decline the loss in case of rice by ration1:4. Ricardo therefore
suggested that if Country A focuses on production of wheat and Country B on
production of rice then international trade can easily be traded between A and
B Countries practically.
Assumptions:
1. Only two commodities are involved in
international trade.
2. Only two countries are involved in international
trade.
3. Labour is only factor of production.
4. There is perfect competition in product and
factor market.
5. Free Trade exists between two countries i.e.
there is no hurdle of tariff and non tariff barriers.
6. Good Trade relation exists between countries.
CRITICISMS:
1. Wrong
Assumption of Two Countries and Two Goods: The theory is
based on hypothetical and unrealistic assumption of two countries and two goods
where international trade takes place. However, trade takes place among various
countries in numerous goods.
2.Negligence of
Transportation Cost:This theory is based on assumption that
there is no transportation cost in export and import. In practice,
transportation cost is always included in price of the commodities while they
are exported and imported. This directly affects international trade.
3.The concept of
Free Trade, Full Employment and Perfect Competition does not exist in real
world:This theory has assumed that there is not any kind
of restriction to transact goods between countries. In reality, countries
impose various types of restrictions to protect and boost up industries in the
country. Likewise, there is never full employment and perfect competition in
the world.
4.Wrong Concept
of Factor Mobility:This theory is based on perfect mobility
of factor of production i.e. labour within the country. But due to various
restrictions labours may be unable as well as hesitate to move from one part of
the country to another and from one industry to another. It is also wrong
belief that labour is immobile outside the country.
5.Labour is not
the only Factor of Production:This theory says that
labour is only one factors of production. However, the reality is quite
different because there are various factors of production that are equally
important in production process because labour alone cannot complete the
production activities.
WORLD TRADE
ORGANIZATION (WTO)
World Trade Organization (WTO) is one of the special
organizations of the United Nations. It is the modern form of GATT (General
Agreement on Trade and Tariffs). GATT was first established in 1947 with the
objective to extend foreign trade among the member countries by eliminating
barriers which arise in the process of international trade. The eights GATT
conference held in Uruguay in 1994 declared to establish WTO. Consequently, WTO
which was established on 1 January 1995, is supposed to be the strong pillar of
the world economic system. The main objective of WTO is to provide common
institutional framework for the conduct of trade relations among its members in
related matters. The headquarters of WTO is located at Geneva in Switzerland.
WTO now has 153 member countries and Nepal is its 147th member. In
the year 2003 Nepal received the membership of WTO.
Objectives of
WTO:
1. To solve trade conflicts between member nations.
2. To simplify and reduce custom duties and other
trade barriers among member nations.
3. To achieve sustainable economic development in
each member nation.
4. To preserve and promote environmental resources
in scientific way.
5. To mobilize the resources to increase real
income, effective demand and employment opportunities.
6. To promote the production and trade of goods and
services.
Principles of
WTO:
1. To carry out international trade without discrimination.
2. To ensure free trade among member nations.
3. To provide security guarantee.
4. To develop open, fair, healthy and liberal
competition among the member nations regarding their individual and commercial
activities.
5. To give priority on economic development process
of developing nations through provision of subsidies to their product.
6. To give member nations more time to adjust
greater flexibility and special facilities.
South Asian Free
Trade Area (SAFTA)
The South Asian Free Trade Area (SAFTA) was
established by SAARC member countries for the development of regional trade and
cooperation in the South Asian region. The concept of SAFTA was introduced in
the 11th SAARC summit held in Kathmandu. The final agreement to
implement SAFTA was made in the 12th SAARC summit held in Pakistan.
SAFTA came into existence since 1st January 2006. Before SAFTA,
SAPTA (South Asian Preferential Trading Agreement) existed. Due to the
ineffectiveness of SAPTA, SAFTA was established with an aim to expand the
economic cooperation among the SAARC nations.
Objectives of
SAFTA:
1. To promote fair competition in the free trade
area.
2. To eliminate barriers of trade among member
nations.
3. To create effective mechanism for implementation
of trade agreement.
4. To establish a framework for further regional
cooperation.
Principles of
SAFTA:
1. SAFTA will be governed by rules, regulations,
decisions, understanding and protocols (first and original draft of agreement)
2. The contracting states affirm (declared positively)
their existing rights and obligations.
3. SAFTA shall be based and applied on the principle
of overall reciprocity (principle of give and take) and mutual advantages.
4. SAFTA shall involve in free movement of goods.
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