By Stephen Simpson
International trade is the exchange of goods, services and capital across national borders. It is a multi-trillion dollar activity, central to the GDP of many countries, and it is the only way for people in many countries to acquire resources they require. Absent trade, consumers and suppliers are forced to either develop substitute goods or devote a large percentage of their income to acquiring products where demand is inelastic and domestic supply is inadequate.
Two of the key concepts in the economics of international trade are specialization and comparative advantage.
It seems readily apparent that countries can benefit from trade if each country does something better than the other (i.e. can produce goods or services at a lower cost). What if one company is more efficient in every good? This situation is called absolute advantage.
Even in situations of absolute advantage, though, there can be benefits to trade. As long as a country is not equally superior in producing all goods, there will be different relative costs for producing various goods. This is where comparative advantage comes in; so long as the two countries have different relative efficiencies, the two countries can benefit from trade – the country with absolute advantage will still benefit by directing its resources to those goods where it is most productive and trading for the others.
Specialization refers to this process; countries (as well as individual businesses) can maximize their welfare by specializing in the production of those goods where they are most efficient and enjoy the largest advantages over rivals. (For more on advantages, check out Competitive Advantage Counts.)
A country's balance of payments basically tracks the financial flows between trading partners. The balance of payments includes the payments made for imports and exports, as well as financial transfers. Exports create a positive entry, while imports are a negative. That said, a balance of payments must always balance out at zero – a trade deficit (more imports than exports) must be balanced with foreign investments, declines in reserves, or increased debt; likewise, a trade surplus will be balanced out with financial outflows or increased reserves.
Within a nation's balance of payment is the current account. The current account is made up primary of a company's trade balance (exports minus imports), as well as net interest and dividends, and net transfer payments (like foreign aid). (To learn more on a nation's balance of power, check out What Is The Balance Of Payments?)
Impediments to Trade
While free trade is generally thought of as a positive, countries will periodically put up barriers to trade. Tariffs are taxes on imports that make imported goods more expensive and less competitive relative to domestically-produced goods. While national governments used to obtain a significant percentage of their receipts from tariffs (in the days before income taxes were common), tariffs today are more commonly used to protect domestic industries and/or to punish other countries for perceived wrongdoing (typically subsidizing local industries to the detriment of the importing country's industries).
Subsidies are transfer payments given by governments to domestic suppliers of goods or services. The motivation to provide subsidies is to increase production and/or lower prices for a country's consumers and/or to make domestically-produced goods more competitive with imports.
Quotas are limits on the amount of a good that can be imported in a given period. Quotas serve a similar purpose to tariffs in that the increase the price of imported goods, but quotas can be even more severe as no additional goods are available once the quota level is reached. (For more on international trade, see What Is International Trade?)
InvestingThe balance of trade is the difference between the value of all the goods and services a country exports and the goods and services it imports.
InsightsThe balance of trade is the difference between a country’s imports and exports. A trade deficit occurs when a country buys or imports more goods from other countries than it sells or exports. ...
InsightsEverything you need to know - from the different types of tariffs to their effects on the local economy.
InvestingAn import is a good or service that’s brought into one country from another.
InvestingAn export is a good or service that is shipped from one country to another for sale or trade.
InsightsEveryone's talking about globalization, so we explain what is it and why some oppose it.
InvestingThe current account reflects the difference between a country’s savings and investments.
InvestingTerms of trade measures a country’s trading efficiency.
InvestingIn business, quota usually refers to the sales target for a salesperson or a sales team.
InvestingFree trade exists when nations can swap goods and services without the constraints of tariffs, duties or quotas.