What is International Trade?

As its name implies, international trade is the exchange of products, services,

and money across national borders; essentially trade between countries. When
consumers in the U.S. purchase Swiss-made watches, Guatemalan-grown fruits,
Chinese-made toys and electronics, and Japanese-manufactured automobiles, they
experience the end result of international trade.

Also known as foreign trade, international trade has been maintained since the
dawn of time. Trading goods were transported on the backs of tradesmen across tribal
boundaries, and bartered and sold among neighboring, and, hopefully, accommodating
tribesmen. The Silk Road between Europe and Asia is one example of the sometimes
beneficial, sometimes troubling essentials of international trade. Asian silks and spices
were traded for European technology and weapons, with varying benefits and
consequences.

Domestic trade is the purchase and sale of products and services within a
particular nation’s borders, and is inherently limiting to a modern national economy.
International trade, conversely, raises national gross domestic product (GDP) by
providing vastly expanded economic opportunity. It is, therefore, incumbent upon the
global economic community to promote fair trade between nations. In addition, the
ability of nations to trade freely with all others is also vital for profits. Free trade, fair
trade, and profits are the cornerstones of global economic well-being.

There is a somewhat cyclical nature to international trade. Poorer nations, able

to provide cheap labor and lower production costs, are subservient to richer and more
consumer-oriented nations. As the productive nations gain wealth through their
productivity, the consumer nations are forced to become productive themselves
through the transfer of their capital to the productive nation. Thus, the process is
reversed. The burgeoning imbalance of trade between the United States and China is
one example of the cycle where the consumer nation is becoming economically
beholden to the producing nation.

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 International trade is most commonly recognized in the exchange of goods or
products. However, trading services, such as expertise in a particular field, or the
ability to facilitate the trade of goods, is another common form of foreign trade.

Trading capital on the foreign exchange market (FOREX) represents a third

facet of international trade. Capital, or currency, held for foreign trade fluctuates in
value hourly due to political, business, weather and other conditions and factors from
nation to nation. Trading currency in the international market attempts to profit from
the rising value of one nation’s currency through selling the lower value of another
nation’s capital. Trading capital is also the amount of money designated by a trader to
pay the costs of foreign trade, such as tariffs, subsidies, transportation, etc.

Importance of International Trade

The buying and selling of goods and services across national borders is known as
international trade. International trade is the backbone of our modern, commercial
world, as producers in various nations try to profit from an expanded market, rather
than be limited to selling within their own borders. There are many reasons that trade
across national borders occurs, including lower production costs in one region versus
another, specialized industries, lack or surplus of natural resources and consumer
tastes.

One of the most controversial components of international trade today is the

lower production costs of “developing” nations. There is currently a great deal of
concern over jobs being taken away from the United States, member countries of the
European Union and other “developed” nations as countries such as China, Korea,
India, Indonesia and others produce goods and services at much lower costs. Both the
United States and the European Union have imposed severe restrictions on imports
from Asian nations to try to stem this tide. Clearly, a company that can pay its
workers the equivalent of dollars a day, as compared to dollars an hour, has a distinct
selling advantage. Nevertheless, American and European consumers are only too
happy to lower their costs of living by taking advantage of cheaper, imported goods.

Even though many consumers prefer to buy less expensive goods, some
international trade is fostered by a specialized industry that has developed due to
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national talent and/or tradition. Swiss watches, for example, will never be price-
competitive with mass produced watches from Asia. Regardless, there is a strong
market among certain consumer groups for the quality, endurance and even “snob
appeal” that owning a Rolex, Patek-Philippe or Audemars Piguet offers. German
cutlery, English bone China, Scottish wool, fine French silks such as Hermes and
other such products always find their way onto the international trade scene because
consumers in many parts of the world are willing to foster the importation of these
goods to satisfy their concept that certain countries are the best at making certain
goods.

One of the biggest components of international trade, both in terms of volume

and value of goods is oil. Total net oil imports in 2005 are over 26 million barrels
per day (U.S. Energy Information Administration figures) (Note: Imports include
crude oil, natural gas liquids, and refined products.) At a recent average of $50 per
barrel, that translates to $1billion, three hundred million, PER DAY. The natural
resources of a handful of nations, most notably the nations of OPEC, the Organization
of Petroleum Exporting Countries, are swept onto the international trade scene in
staggering numbers each day, and consumer nations continue to absorb this flow.
Other natural resources contribute to the movement of international trade, but none to
the extent of the oil trade. Diamonds from Africa, both for industrial and jewelry use,
wheat and other agricultural products from the United States and Australia, coal and
steel from Canada and Russia, all flow across borders from these nations that have the
natural resources to the nations that lack them.

Despite complaints about trade imbalances, effects on domestic economies, currency

upheavals, and loss of jobs, the reality of goods and services continually crossing
borders will not go away. International trade will continue to be the engine that runs
most nations.

Benefits of International Trade

International trade has flourished over the years due to the many benefits it has
offered to different countries across the globe. International trade is the exchange of
services, goods, and capital among various countries and regions, without much

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hindrance. The international trade accounts for a good part of a country’s gross
domestic product. It is also one of important sources of revenue for a developing
country.

With the help of modern production techniques, highly advanced

transportation systems, transnational corporations, outsourcing of manufacturing and
services, and rapid industrialization, the international trade system is growing and
spreading very fast.

International trade among different countries is not a new a concept. History

suggests that in the past there where several instances of international trade. Traders
used to transport silk, and spices through the Silk Route in the 14th and 15th century.
In the 1700s fast sailing ships called Clippers, with special crew, used to transport tea
from China, and spices from Dutch East Indies to different European countries.

The economic, political, and social significance of international trade has been
theorized in the Industrial Age. The rise in the international trade is essential for the
growth of globalization. The restrictions to international trade would limit the nations
to the services and goods produced within its territories, and they would lose out on
the valuable revenue from the global trade.

The benefits of international trade have been the major drivers of growth for
the last half of the 20th century. Nations with strong international trade have become
prosperous and have the power to control the world economy. The global trade can
become one of the major contributors to the reduction of poverty.

David Ricardo, a classical economist, in his principle of comparative

advantage explained how trade can benefit all parties such as individuals, companies,
and countries involved in it, as long as goods are produced with different relative
costs. The net benefits from such activity are called gains from trade. This is one of
the most important concepts in international trade.

Adam Smith, another classical economist, with the use of principle of absolute
advantage demonstrated that a country could benefit from trade, if it has the least

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absolute cost of production of goods, i.e. per unit input yields a higher volume of
output.

According to the principle of comparative advantage, benefits of trade are

dependent on the opportunity cost of production. The opportunity cost of production
of goods is the amount of production of one good reduced, to increase production of
another good by one unit. A country with no absolute advantage in any product, i.e.
the country is not the most competent producer for any goods, can still be benefited
from focusing on export of goods for which it has the least opportunity cost of
production.

Benefits of International Trade can be reaped further, if there is a considerable

decrease in barriers to trade in agriculture and manufactured goods.

Some important benefits of International Trade

 Enhances the domestic competitiveness

 Takes advantage of international trade technology
 Increase sales and profits
 Extend sales potential of the existing products
 Maintain cost competitiveness in your domestic market
 Enhance potential for expansion of your business
 Gains a global market share
 Reduce dependence on existing markets
 Stabilize seasonal market fluctuations

International Trade Terms

Here are some important terms related to international trade.

Acceptance: The act of giving assurance in writing on the face of a bill of exchange
stating the payment of a bill on the date of maturity.
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Acceptance Credit: A documentary credit, which requires the beneficiary to draw a
usance bill for subsequent acceptance by the issuing

Accommodation Bill: In the context of fraud, a bill drawn without a genuine

underlying commercial transaction.

Accountee: Another name for the applicant or opener of a documentary credit

Amendment: Any changes to the term of a DC must be initiated by the applicant and
issued and advised to the beneficiary

Applicant: Any party, usually the importer, who applies for a documentary credit.

Back-to-Back Credit: A credit issued on the security of an existing credit ("the

master credit").

Beneficiary: A payee or recipient, usually of money or a party in whose favor a

documentary credit is established, usually the exporter.

Bill for Collection (BC): Document(s) or check(s) submitted through a bank for
collection of payment from the drawee.

Bill of Exchange (B/E): An unconditional order in writing, addressed by one person

to another, signed by the person giving the order.

Bill of Lading (B/L): A receipt for goods for shipment by sea. It is a Document of
Title

Bill Receivable (BR): Bills which are financed by the receiving branch, whether
drawn under a DC or not, are treated as Bills Receivable by both the remitting branch
and the receiving branches.

Carrier: Person or company whose business is the conveyance of goods e.g. shipping
company

Chaser: Reminder sent by the collecting (or DC issuing) bank to the importer,
repeating a request for payment.

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Clean Collection: A draft with no documents Collection attached - see “Collections –
Introduction”.

Clean Import Loan (CIL): A loan granted to an importer for payment of import
bills, without the Bank having any claim to the goods.

Collection Bank: The bank in the drawee's country that is instructed to collect
payment from the drawee.

Collection Order: A form submitted by an exporter to the remitting or negotiating

bank, accompanied by documents, and carrying the exporter's instructions.

Consignment: Shipment of goods.

Consignee: The person or company/bank to whom the goods are delivered - usually
the importer or the Collecting Bank.

Consignor: The party who sends goods by ship, by land or air.

Contingent Liability: A liability that arises only under specified conditions.

Deferred Payment Credit (DPC): Using stipulated documents, a bank can effect
payment on a DC at a maturity date that is specified or determinable in the credit
terms.

Demurrage: A charge made by a shipping company or a port authority for failure to

load or remove goods within the time allowed.

Discounting: An accepted usance bill of exchange is sold at an amount less than its
face value.

Dishonor: Non-payment or non-acceptance.

Documentary Credit (DC): A conditional undertaking by a bank to make payment,

often abbreviated to “credit”.

DC Bills: Bills drawn under documentary credits.

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Documents Against Acceptance (D/A): Instruction for commercial documents to be
released to the drawee on acceptance of the bill of exchange.

Documents Against Payment (D/P): Instruction for documents to be released to the

drawee only on payment.

Documents of Title: Documents that give their owner the right to the goods, i.e. Bill
of Lading.

Due Date: Maturity date for payment

Expiration Date: Latest date, usually in the country of the beneficiary, on which
negotiation/payment of a DC can take place.

Export Line: Financing for exporters.

Financed Bills: Bills sent on collection in which the remitting bank has a financial
interest.

Foreign Bill Purchased (FBP): A bill remitted to a correspondent bank in which the
remitting bank is financing the exporter

Forward Exchange Contract: Contract between the bank and its customer to
buy/sell a fixed amount of foreign currency at a future date at a specified rate

Freight: Goods OR the cost of transporting goods.

Import License: A permit issued by the importing country's authorities for goods that
are subject to import licensing restrictions.

Import Line: Finance facilities for importers covering documentary credits (DC),
bills receivables (BR), and import loans (LAI).

Incoterms: Shipping Terms

International Chamber of Commerce (ICC): The international body which

promotes and facilitates world trade, and which codifies world trade practices in
various publications
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Inward BC: A bill received by the import department of the collecting bank (IBC).

Issuing Bank: The bank that opens a documentary credit at the request of its
customer, the applicant.

Letter of Credit (L/C): Out of date term for documentary credit. Avoid using it, as it
now has other meanings.

Letter of Hypothecation: Loan-holders for goods imported on a collection basis must

provide a letter of hypothecation, which is a promise to hold goods as security.

Loan Against Imports (LAI): Loans granted to Imports customers for payment of
bills, usually bills under our DC.

Marginal Deposit: Money held by the Bank to secure the opening of a DC. Normally
no interest is paid on these deposits which are held in the Bank’s name whenever
possible.

Master Credit: In back-to-back operations, the original export credit against which
the second credit is opened

Maturity: Payment due date of a usance bill or promissory note.

Net Weight: The weight of the merchandise before any packaging.

Non-DC Bills: Bills not drawn under DC i.e. sent on a collection basis (D/P or D/A).
Non DC bills are financed collections and DC bills are non-financed collections.

Non-Financed Bills: Bills sent on collection in which the remitting branch has no
financial interest.

Outward BC: Bill received for collection by the (OBC) Remitting Bank, handled by
the Exports Department.

Paying Bank: The bank that makes payment to the beneficiary of a payment DC after
presentation to it of documents stipulated in the DC.

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Perils of the Sea: These are accidents or casualties of the sea due to heavy or
tempestuous weather

Power of Attorney: Authority given to one party to act for another

Presentation: The act of requesting the importer's payment/acceptance of an import

bill

Presenting Bank: The bank that requests payment of a collection bill. This may be
the collecting bank or its nominated branch

Principal: The initiator of a given transaction whose instructions are followed at all
stages. In collection transactions the principal is generally the exporter. In other cases
the principal may be the customer who opens a DC.

Promissory Note: A signed statement containing a written promise to pay a stated

sum to specified person at a specified date or on demand.

Recourse; The right to claim a refund from another party who has handled a bill at an
earlier stage.

Red Clause Credit: A credit with a clause, which authorizes the advising bank to
make an advance payment to the beneficiary

Reimbursing Bank: The bank that the DC-issuing bank has named to pay the value
of the DC to the negotiating or paying bank.

Remitting Bank: The exporter's bank, which remits the bill to the collecting bank.

Revolving Credit: A credit that is automatically reinstated each time a draw takes
place or upon receipt of authorization from the DC-issuing bank.

Retirement: To pay or settle an outstanding bill or import loan. Example: payment to

the bank by the importer.

Revocable Credit: Credit that may be amended or canceled without notice to the
beneficiary.

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Shipment Date; A bill of lading evidences that goods have been received on board.
Therefore the date that is entered on the B/L is considered to be the shipment date for
documentary credit purposes.

Self-Liquidating: A transaction is said to be self-liquidating when there is a known

source of funds available for its settlement on the due date.

Standby Credit: Established as security for facilities granted at another branch or

bank

Shipping Register: The register that lists all goods for which the imports department
is handling documents, listed according to the ship carrying the goods.

Snags: Irregular bills, whether for import, or export.

Technical D/A: A D/P transaction in which the bank purchases bills but it does not
control the goods.

Trade Financing General Agreement (TFGA): An agreement between the bank and
all of its import and export customers that gives the bank recourse in all transactions.

Trade and Credit Information (TCI): The bank department that provides details of
the creditworthiness and business background of traders and manufacturers.

Transferable Credit: Permits the beneficiary to transfer all or some of the rights and
obligations of the credit to a second beneficiary or beneficiaries

Trust Receipt (T/R): A T/R is issued for a TFGA transaction and is based upon the
terms of the TFGA.

Transit Interest: The amount of interest that is incurred on a DC from the date of
negotiation to the date that the bank receives reimbursement.

Usance Bill: A bill of exchange, which allows the drawee to have a usance (period of
credit or term).

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Undertaking: A written promise to deliver a security within the time specified. An
undertaking is usually synonymous with the actual delivery of the security.

Waive: A drawer can waive the right to collect BC and/or interest charges under
circumstances as set forth in ICC 522, Uniform Rules for Collections.

The Benefits of International Trade and its Dependencies on the United States

The term Global Economy refers to the economic system of world and the
interdependency among the various nations of the world. While we may not always
think about the global economy as being very meaningful in our lives, its health is
critical to our own success. But overall, the process of international trade involves the
transaction of services, goods and monetary instruments among and between
countries. With the availability of accurate, timely and affordable translation services,
businesses can have trusting relationships with their trade partners and trade can
flourish.

Over the next several weeks, we will be contributing new articles that focus on
the important role that translators play in terms of the global economy. It’s critically
important that the world has an unending supply of accurate translation workers
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because corporations that operate on a global level like Google, Toyota, General
Motors and Ford must make decisions based on good data.

So what does the term trade mean in today’s global economy? The term
‘Trade’ can imply a certain industry, like the building or construction trade. Further,
the terms can also mean a particular occupational field, such as brain surgery. Further,
the term trade can also be used to signify people who work in a specific field such as
the real estate trade. However, for this paper we will be discussing trade as it relates to
the exchange of services and goods in an international context. Trading goods and
services allows countries to meet their individual wants and needs as well as to help
their own economy.

Domestic trade differs from global trade in the fact that it centers around the
exchange of goods and services within one country. The term world trade might also
be used to describe the area of trade that takes place over international boundaries.
Certain professional service providers, such as German Translation Services agencies
are a necessity for such activities. International or global trade creates a number of
advantages that include the simplified flow of goods, services, and capital flow freely
across U.S. borders, Americans can take full advantage of the opportunities of the
international marketplace. In other cases, businesses in one country may produce
better products or services at cheaper prices than businesses in other countries. This is
why international trade takes place.

Since the 1970s, world trade and the need for highly accurate and specialized
translation services have increased considerably. Advances in technology and
transportation, along with increased numbers of communications agencies, like
Japanese Translation Services companies, help to create more international trade by
breaking down barriers. Developments such as these also improve the economic
outlook of many countries. To illustrate the importance of imports and exports to the
language translation industry, consider how Korean Translator companies benefit
from buying pepper from the Hindi speaking country of India. In addition, Korean
engages in trade with Spanish speaking countries when it purchases bananas from
Honduras, coffee from Colombia, and electronic components from Japan and China.
Importing is when country A buys goods or services from country B. Korean

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translators is intimately involved in the advertising and selling process when Korea
sells items to other countries abroad. These products, which were made in Korea, are
also known as exports. Exports are goods and services that one country sells to
another country. Investment in other countries is also undertaken by Korea when it
establishes a business there. The services of professionals, like engineers and health
care workers are also imported and exported by Korea. Whether a good is an export or
an import depends on whether the country is buying or selling it.

A trade surplus exists when a country has more exports than imports. A trade
deficit occurs when a country has imported more than it has exported. A balance of
trade is what you get when you determine the difference between exports and imports
during a specific period of time. Many countries have a trade surplus with country A
and a trade deficit with country B. As an example, the USA balance of trade is
favorable vis a vis Australia. In other words, the USA earns more in sales to Australia
than Australia earns in sales to the USA. The United States has an unfavorable
balance with France, which means the United States takes in less money from sales to
France than France takes in from sales to the United States.

The advantages and disadvantages of foreign trade:-

The trade between two or more nations is termed as foreign trade or

international trade. It involves exchange of goods and services between the trades of
two countries. Foreign trade consists of import trade, export trade and entrepot trade.
In the early stages of human civilization, production was confined as per
consumption. Human wants were limited. Now-a-days, human wants are increasing
and as such no man was considered to be self-dependent. Like this no country can live
in isolation and claimed the status to be self-sufficient. Because of this reason
countries have trade relationships with each other. The primary objective of foreign
trade is to increase foreign trade and increase the standard of living of its people.
There is an increasing demand for foreign trade because of the following
reasons:

 The natural resources are unevenly distributed.

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  The presence of specialization and division of labour.

 Different countries have difference in economic growth rate.

 The presence of the theory of comparative cost.

The following are some of the advantages of foreign trade:

Ø Optimum use of Resources: Foreign trade helps in the optimum use of

natural resources and avoid wastages of resources.

Ø Stable Price: It ensures the presence of stable price by avoiding wide

fluctuations in prices. It tries to equalise the world price.

Ø Availability of all types of goods: It enables a country to import those goods

which it cannot produce.

Ø Increased Standard of living: It ensures more production to meet the demand

of the people of different countries. By increased production, it becomes
possible to increase income and the standard of living of its people. It also
increases the standard of living by increasing more employment opportunities.

Ø Large Scale production: It ensures large production because the production is

carried on to meet the demand of its people as well as world market. Large
scale production also ensures a great deal of internal economies which reduces
the cost of production.

Foreign trade is not free from difficulties. The following are some of the
important disadvantages of foreign trade:

Θ It is a long distance trade and as such it becomes difficult to maintain close

relationship between the buyer and the seller.

Θ Each country has its own language. As foreign trade involves trade between
two or more countries, there is diversity of languages. This difference in
language creates problem in foreign trade.

Θ Foreign trade involves preparation of a number of documents which also

creates difficulties in the way of foreign trade.

Θ Some restrictions are imposed on export and import of commodities. These

restrictions stand on the progress of foreign trade.

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 Θ Foreign trade involves a great deal of risks because trade takes place over a
long distance. Though the risks are covered through insurance, it involves
extra cost of production because insurance cost is added to cost.

Trade Barrier
Trade barriers are any of a number of government-placed restrictions on trade
between nations. The most common sorts of trade barriers are things like subsidies,
tariffs, quotas, duties, and embargoes. The term free trade refers to the theoretical
removal of all trade barriers, allowing for completely free and unfettered trade. In
practice, however, no nation fully embraces free trade, as all nations utilize some
assortment of trade barriers for their own benefit.

Tariffs are a fairly common form of trade barriers, and are essentially taxes on
goods as they cross the borders of a nation. Tariffs nearly always are placed on goods
that are brought into the country, as opposed to goods sold as exports, although in
some cases they may go both ways. Historically, tariffs were a large source of
government revenue, as they could easily be collected as a tax on ships as they landed
in the nation.

Tariffs, like most trade barriers, may be imposed for different reasons. Some
tariffs are placed simply to earn money for the government. This might either be a flat
fee on an item, or it might be based on the market value of the item. Other tariffs exist

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as a form of protectionism, to make imported goods more expensive than they might
otherwise be, in order to protect domestic industries. For example, if a country has a
fairly high wage, and high labor standards, the cost of producing a single widget
might be around ten units. If a nearby country can produce a widget for three units,
then imports of that country’s widgets could easily drive the domestic industry out of
business. So the country might place a restrictive tariff on widget imports, to make
sure that domestic widgets always remained competitively priced, or even to make it
unfeasible for widgets to be imported at all.

Subsidies are another of the common trade barriers, and are often placed to
protect domestic industries. Subsidies may actually be intended simply to make
certain key goods affordable to citizens of the nation, but the end result can still be to
make imports non-competitive. Many food crops, for example, are heavily subsidized,
to ensure the citizenry has a constant supply of affordable food. Steel is also often
subsidized, to ensure a nation always has a domestic steel supply, which can be
crucial during times of war when normal shipping avenues may be cut off.

An embargo can be seen as the most extreme of the trade barriers. Embargoes
basically prohibit the import or export of anything with another country. This is often
done as a form of punishment, or to try to force the country to undergo radical change
internally as a result of a weakened economic state. Historically, the embargo was
used as a war tactic, and so was often considered a declaration of war. In modern
times, however, although the most brutal of the trade barriers, it is usually not viewed
as an act of outright aggression, although a declaration of war is often accompanied by
an embargo.

A number of free trade bodies exist in the world to try to curtail the use of
trade barriers by nations. The World Trade Organization is perhaps the widest
reaching of these bodies, and it enforces strict rules against member nations,
restricting the acceptable use of things like tariffs. As a result, some countries have
begun using trade barriers that are not tariffs, but have similar effects. The European
Union, for example, does not allow the import of many genetically-modified
organisms, which effectively bans the vast majority of food imports from the United

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States. In recent years, groups like the WTO have begun to look at these forms of
trade barriers as well, and to strip them when possible.

Trade barriers refer to government-imposed policies to restrict international

trade. Most commonly, a country’s government employs tariffs, duties, embargoes
and subsidies as trade barriers. However, imposing trade barriers are against the
concept of free trade, popularized by developed nations.

Almost every trade barrier works as a tool to ensure a protectionism policy.

Trade barriers aim to hike the prices of imported products in order to secure the
domestic industry against fierce competition from foreign products.

Some of the most common trade barriers are:

Tariffs:

Taxes levied on products that are traded across borders are called tariffs.
However, governments impose tariffs essentially on imports and not on exports.

Two most popular types of tariffs are:

 Ad valorem: This tariff involves a set percentage of the price of the imported
goods.
 Specific: This refers to a specific amount charged by the government on
import of goods.

Subsidies:

Subsidies work to foster export by providing financial assistance to locally-

manufactured goods. Subsidies help to either sustain economic activities that face
losses or reduce the net price of production.

Quotas:

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 Import quotas are the trade limits set by the government to restrict the quantity
of imports during a specified period of time.

Embargo:

This is an extreme form of trade barrier. Embargoes prohibit import from a

particular country as a part of the foreign policy. In the modern world, embargoes are
imposed during wartimes or due to severe failure of diplomatic relations.

Economic Impact of Trade Barriers

In times of flourishing international trade, imposing trade barriers prevents the

nation from fully realizing the economic benefits of such globalized trade. A
protectionism regime causes over-allocation of resources in the protected sector and
exploitation or under-allocation of resources in free trade sectors. This usually leads
the country into economic disequilibrium, which hampers growth.

Import restrictions affect international trade relations, which in turn leads to a

decline in exports. Thus, the protectionism regime that is employed to protect certain
sectors actually tends to retard the growth of the entire economy.

Free trade environments offer greater and better choices in the market, leading
to enhanced consumer satisfaction. With trade barriers in place, the government curbs
consumer rights to enjoy competition in the market.

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Balance Of Trade - BOT

Balance Of Trade - BOT means the difference between a country's imports and
its exports. Balance of trade is the largest component of a country's balance of
payments. Debit items include imports, foreign aid, domestic spending abroad and
domestic investments abroad. Credit items include exports, foreign spending in the
domestic economy and foreign investments in the domestic economy. A country has a
trade deficit if it imports more than it exports; the opposite scenario is a trade surplus.
Also referred to as "trade balance" or "international trade balance"

The balance of trade is one of the most misunderstood indicators of the U.S.
economy. For example, many people believe that a trade deficit is a bad thing.
However, whether a trade deficit is bad thing is relative to the business cycle and
economy. In a recession, countries like to export more, creating jobs and demand. In a
strong expansion, countries like to import more, providing price competition, which
limits inflation and, without increasing prices, provides goods beyond the economy's
ability to meet supply. Thus, a trade deficit is not a good thing during a recession but
may help during an expansion.

The value of balance of trade is expressed in domestic currency and is denoted

by the symbol, ‘NX’.

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 Trade balance is a reflection of a country’s international market and its
domestic consumption. A country’s balance of trade comprises a major segment of
balance of payments. This is an effective mechanism to quantify a country’s overall
economic transactions with the rest of the world. It also affects the country’s overall
GDP for that particular period.

Composition of Trade Balance

For a given country, trade balance comprises those products that a country trades on
with other countries. Factors that affect trade balance are:

♣ Demand and supply:

The demand and supply trend defines the cost of domestic products to
be sold in the international market.

♣ Domestic business:
Sound, domestic policies are required to boost production and
international trade. Some countries like the US provide subsidies to local
manufacturers for exported goods and services.

♣ Trade agreements:
Bilateral agreements govern international trade and define the products
and their prices in the global context.

♣ External pressures:

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 Many countries export items that face heavy competition in
international market. This results in market segmentation and low pricing.
Countries that are mostly oil exporters or IT hubs tend to generate favorable
trade balance due to less competition in the international market. External
pressures also work in the form of trade bans. These bans are enforced by
either individual countries or international organizations such as the WTO or
IMF.

♣ Exchange rate:

o For nations
with low exchange rate
♣ values, balance of trade tends to remain unfavorable. Proactive market policies
are required to ensure that a country’s trade balance remains favorable. A
sound trade balance represents an important benchmark as it reflects economic
stability between nations. It fortifies trade ties with other countries and
generates immense possibilities to stem job losses, inflation and
unemployment.

Determinants of the Balance of trade

There are three major determinants of the trade balance or net exports: Foreign
exchange rates, national incomes, and domestic and foreign price levels.

Effects of the foreign exchange rate:

The way the foreign exchange rate affects exports and imports has already
been discussed in fair detail. In a nutshell, if the U.S. dollar appreciates (the dollar
becomes stronger and the foreign exchange rate increases), exports decline and
imports increase, causing the foreign trade deficit to rise. If the dollar depreciates (the
dollar becomes weaker and the foreign exchange rate decreases), the foreign trade
deficit falls.

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Effects of changes in domestic and foreign incomes:

Changes in national incomes in foreign countries as well as in the United

States have an important effect on net exports. If national incomes in foreign countries
rise, foreign residents demand greater amounts of goods and services, some of which
can be bought from the United States. As a result, an increase in incomes in foreign
countries leads to an increase in U.S. exports, causing the foreign trade deficit to rise
(assuming other factors do not change). If national incomes in foreign countries fall,
U.S. exports to these countries will decline, leading to a decline in the foreign trade
deficit as well.

If the U.S. national income rises, U.S. consumers demand more goods and
services, and some of this increased demand is for goods and services produced in
other countries. As a result, a rise in U.S. income increases U.S. imports, causing the
foreign trade deficit to rise. On the other hand, if the U.S. national income declines,
the demand for goods and services by U.S. consumers falls, so does the demand for
imported goods and services—this leads to a decrease in the foreign trade deficit.

From the preceding discussion, it follows that changes in net exports are also
tied to rates of economic growth, both home and abroad. While U.S. policy makers
have some control over the rate of economic growth in the United States, they cannot
unilaterally influence rates of economic growth in foreign countries. As a result, U.S.
policy makers do not have complete control of the behavior of U.S. net exports.

Conditions where trade imbalances may be problematic

Those who ignore the effects of long run trade deficits may be confusing
David Ricardo's principle of comparative advantage with Adam Smith's principle of
absolute advantage, specifically ignoring the latter. The economist Paul Craig Roberts
notes that the comparative advantage principles developed by David Ricardo do not
hold where the factors of production are internationally mobile. Global labor
arbitrage, a phenomenon described by economist Stephen S. Roach, where one
country exploits the cheap labor of another, would be a case of absolute advantage

23
that is not mutually beneficial. Since the stagflation of the 1970s, the U.S. economy
has been characterized by slower GDP growth. In 1985, the U.S. began its growing
trade deficit with China. Over the long run, nations with trade surpluses tend also to
have a savings surplus. The U.S. generally has lower savings rates than its trading
partners which tend to have trade surpluses. Germany, France, Japan, and Canada
have maintained higher savings rates than the U.S. over the long run.

Few economists believe that GDP and employment can be dragged down by
an over-large deficit over the long run. Others believe that trade deficits are good for
the economy. The opportunity cost of a forgone tax base may outweigh perceived
gains, especially where artificial currency pegs and manipulations are present to
distort trade.

Wealth-producing primary sector jobs in the U.S. such as those in

manufacturing and computer software have often been replaced by much lower paying
wealth-consuming jobs such those in retail and government in the service sector when
the economy recovered from recessions. Some economists contend that the U.S. is
borrowing to fund consumption of imports while accumulating unsustainable amounts
of debt.

In 2006, the primary economic concerns focused on: high national debt ($9
trillion), high non-bank corporate debt ($9 trillion), high mortgage debt ($9 trillion),
high financial institution debt ($12 trillion), high unfunded Medicare liability ($30
trillion), high unfunded Social Security liability ($12 trillion), high external debt
(amount owed to foreign lenders) and a serious deterioration in the United States net
international investment position (NIIP) (-24% of GDP), high trade deficits, and a rise
in illegal immigration.

These issues have raised concerns among economists and unfunded liabilities
were mentioned as a serious problem facing the United States in the President's 2006
State of the Union address. On June 26, 2009, Jeff Immelt, the CEO of General
Electric, called for the U.S. to increase its manufacturing base employment to 20% of
the workforce, commenting that the U.S. has outsourced too much in some areas and
can no longer rely on the financial sector and consumer spending to drive demand.

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Conditions where trade imbalances may not be problematic

Small trade deficits are generally not considered to be harmful to either the
importing or exporting economy. However, when a national trade imbalance expands
beyond prudence (generally thought to be several percent of GDP, for several years),
adjustments tend to occur. While unsustainable imbalances may persist for long
periods (Singapore and New Zealand’s surpluses and deficits, respectively), the
distortions likely to be caused by large flows of wealth out of one economy and into
another tend to become intolerable.

In simple terms, trade deficits are paid for out of foreign exchange reserves,
and may continue until such reserves are depleted. At such a point, the importer can
no longer continue to purchase more than is sold abroad. This is likely to have
exchange rate implications: a sharp loss of value in the deficit economy’s exchange
rate with the surplus economy’s currency will change the relative price of tradable
goods, and facilitate a return to balance or (more likely) an over-shooting into surplus
the other direction.

More complexly, an economy may be unable to export enough goods to pay

for its imports, but is able to find funds elsewhere. Service exports, for example, are
more than sufficient to pay for Hong Kong’s domestic goods export shortfall. In
poorer countries, foreign aid may fill the gap while in rapidly developing economies a
capital account surplus often off-sets a current-account deficit. Finally, there are some
economies where transfers from nationals working abroad contribute significantly to
paying for imports. The Philippines, Bangladesh and Mexico are examples of transfer-
rich economies.

Economic impact of balance of trade

Most economists do not believe that trade deficits are inherently good or bad,
but must be judged based on the circumstances in which they arose. Large imbalances
may sometimes be a sign of underlying economic problems or rigidities. An example

25
includes a situation where exchange rates have been fixed or pegged for political
reasons at levels impeding a correction of a trade imbalance.

In order to maintain a negative balance of trade, it must be financed by running

down net international assets relative to the case without a deficit. This may be done
for example by selling assets, through foreign direct investment or by international
borrowing. Potential problems with persistent deficits therefore include the
accumulation of foreign debt with associated interest payments or domestic assets
passing increasingly into the hands of foreigners. Deficits may also have
intergenerational effects: by shifting consumption over time, some generations may
gain at the expense of others (In other words: citizens of countries that run up
cumulative trade deficits leave it to their children to pay the bill, in the form of either
interest and dividend payments to the rest of the world, or to seeing more and more
assets being owned by the rest of the world.)

A large trade deficit, in general terms, can only be sustained as long as the rest
of the world is willing to finance it. If, for whatever reasons, this ceases, a country
may find itself unable to meet its obligations. The mere possibility thereof is likely to
result in a rise in interest rates and/or a depreciation of its currency.

However, a trade deficit may be good news if it is used to finance profitable

domestic investments or if it is temporary and reflects a boom with strong domestic
demand. Further, the consequences of globalization, like the increase of the market
share of multinationals and the international merging of stock exchanges decreases the
relevance of trade balances of countries according to some sources.

The effects of trade imbalances on employment are controversial. It can lead to

the loss of jobs, such as the loss of 1.5 million U.S. jobs to China between 1989 and
2003, though micro economists point out this has not been a gross job loss (the total
employment level has actually increased).

A trade surplus may appear to be a good thing but may not always be so. It is
possible for the terms of trade to be lower than before if there is an improvement in
the balance of trade (e.g. if an export increase came about by lowering prices). In
addition, country with a surplus may come to rely on foreign demand for its industry,
which may be problematic once the foreign demand dries up.

26
 An example of an economy in which a positive balance of payments is
regarded as a bad thing by some is Japan in the 1990s. The positive balance was partly
the result of protectionist measures that also caused the price of goods in Japan to be
much higher than they would have been, had imports been freely allowed. The foreign
currency Japanese companies earned overseas remained largely unconverted into yen
in order to suppress the yen's value, further preventing Japanese consumers from
benefiting from the trade surplus. In addition, the potential benefit from the trade
surpluses were partly squandered by spending it on prestige real estate purchases in
the United States that often proved unprofitable.

Impact on other variables

Trade balance is a component of GDP: other things equal, a surplus increases

GDP and deficit reduces it. If this impact is strong enough, it gives rise to the
traditional Keynesian multiplier effect with consumption moving in the same
direction.

In financial terms, trade balance influence the total size and the composition of
the current-account balance and, more broadly, it influences the balance of
payments (which comprehends not only the trade balance but also income payments,
loans and aid from abroad, etc).

In particular, long-lasting trade deficit can lead to foreign debt, on which a

country has to pay interests. If this debt is judged by market agents as unsustainable, a
currency crises can erupt. Even before that this perspective materialises, the
government can be induced to dampen GDP growth.

Long-term trends

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 Trade imbalances are widespread throughout the world and persistent over
time. In order to reduce the gap with rich countries, poor countries have to rise much
faster than them, which are usually their main commercial partners. But this leads to
trade deficit, which risks jeopardizing growth with alternate phases of "stop-and-go".

Business cycle behaviour

Trade balance tend to be strongly anti-cyclical: in boom periods it usually

exhibits deficits, whereas in recessions a trade surplus can help inverting the business
cycle.

Physical trade balance

Monetary trade balance is different from physical trade balance (which is

expressed in amount of raw materials). Developed countries usually import a lot of
primary raw materials from developing countries at low prices. Often, these materials
are then converted into finished products, and a significant amount of value is added.
Although for instance the EU (as well as many other developed countries) has a
balanced monetary trade balance, its physical trade balance (especially with
developing countries) is negative, meaning that in terms of materials a lot more is
imported than exported. That means the ecological footprint of developed countries is
may be larger than that of developing countries, if footprint mainly depends on bulk
size.

The Politics And Economics Of Foreign Trade

As is clear from the preceding discussions, foreign trade, even if it results in a

deficit on the foreign trade balance, is not all bad. While a foreign trade deficit can be
held responsible for some lost jobs, it also provides consumers with lower prices and

28
greater choice. Debate on the foreign trade deficit in the popular media is often
unbalanced. During the North American Free Trade Agreement debates in the United
States, opponents of the agreement put a lot of emphasis on the "sucking sounds" of
jobs lost to Mexico. The trade deficit with Japan is also often debated in a politically
charged atmosphere, frequently resulting in Japan-bashing. Recently, the attention has
turned to the trade imbalance with the People's Republic of China.

A foreign trade deficit essentially creates a classic conflict between two groups
—workers and consumers. Workers as a group may tend to lose due to lost jobs (but
not all workers lose since jobs are created in import-related industries). Consumers, on
the other hand, gain as explained above. Which group's interest will the government
keep in mind in dealing with trade issues? The answer to this question often boils
down to whichever group has the greater political influence. It so happens that
workers tend to be better organized and they are, thus, able to influence government
trade policy in their favor.

What Is a Trade Surplus?

Trade surplus is a condition in which a country has a positive balance of trade

with other countries. Countries that enjoy a trade surplus have more money flowing in
than out. This includes both money for the products the country exports and the
money spent by foreign visitors to the country. When a nation has a trade surplus, it
has more control over its own currency.

Exports include goods and services produced in a country and sold to one or
more other countries. Country exports are of a higher value than imports. Balance of
trade is the difference between the value of exports and imports within a specified
period of time. A positive balance is a surplus, and a negative balance is a trade
deficit.

A trade surplus indicates that there is more demand for the exports of a
country than there is demand for foreign products and services. There is therefore a
higher employment rate within the country and the standard of living is increased.
Positive balance of trade plays an important role in the economic growth of any
country.
29
 Trade surplus in goods and services not only influences the level of
employment within a country, but it also affects the price level and inflation rate in its
economy. As the demand for a country’s goods and services increase, producers
increase their output to meet the increased demand. This in turn generates additional
income that augments the growth of the country’s economy. When the economy
grows, the output, or gross domestic product, increases and citizens can afford a more
expensive lifestyle.

There are drawbacks to the increase in trade surplus. A rise in net exports will
force production to meet foreign demand by increasing demand for labor and resource
goods and services. Increased demand will increase the cost of wages and raw
material, which increases the cost of production. This leads to raised retail prices of
goods and services. Therefore, as the trade surplus increases so does inflation.

A trade deficit has a dampening effect on the economy in that it slows growth
and increases unemployment as the demand for workers decreases. Whether a deficit
has a negative or positive effect depends on who is being affected. Increasing the
foreign trade deficit, for example, can be good from the viewpoint of the individual
consumer because he or she would end up paying lower prices for goods. Producers
and wage earnings, however, would be adversely affected.

Another measure of trade surplus and trade deficit is how they relate to the
business cycle within an economy. If a country finds itself in a strong expansion, one
strategy is to import more and to provide more price competition. This limits inflation
and provides a more varied supply of goods and services than is normally available.
On the other hand, during a recession the economy would be better served by
exporting more, thus creating more demand and more jobs.

Trade Deficit

A Trade Deficit occurs when the value of a country’s imports exceed its
exports for a specific period of time, usually a year. The relationship between imports
and exports are called the trade balance. When exports exceed imports it is called a
trade surplus. Trade deficits can occur in both developing and advanced countries.
30
The United States, for example, has been running a trade deficit for many years.
While a trade surplus contributes to the GDP of a nation, a trade deficit will reduce
GDP. While economists state that a controlled short term trade deficit is manageable
and in some cases necessary for growth and development, they consider a long-term
trade deficit to be a wealth destroyer that can trigger job losses, increase debts and
lead to possible speculative attacks on currency.

The layman normally thinks of a trade deficit as being bad, but if that deficit
means that goods can be bought at a lower price and therefore corporate can increase
their profit margins and consumers have greater spending power, then a trade deficit
can have beneficial effects.

However, this is not true, as a certain level of trade deficit is required in a

flourishing economy. A growth-oriented economy focuses on imports to provide price
competition, which in turn limits inflation. In contrast, a trade deficit triggers
repercussion during a recession. For instance, the US trade deficit pertaining to goods
and services rose to $27.6 billion in March 2009. Japan is also combating high trade
deficit. In January 2009, Japan’s deficit of ¥952.6 billion indicated that the global
recession had weakened the country’s exports.

A recessive economy endeavors to generate more employment and raise the

demand for domestic products by propelling exports. Hence, a trade deficit has
numerous implications for a country’s domestic business cycle and economic
situation.

Reasons and Implications of a Trade Deficit

A long-term trade deficit leads to an unstable economy, where unemployment,

foreign debt and currency crises become concerns.

Agriculture-based economies may face a trade deficit due to:

 The seasonal nature of trade.

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  Financial soundness of the domestic business, which significantly impacts the
trade balance

 Low domestic production or substandard quality goods downgrade the

monetary value of imports.

The overvaluation of the domestic currency may also lead to a long-term trade
deficit. Static exchange rates and high inflation rates lead to the overvaluation of a
currency. During the 1980s-1990s, Chile, Malaysia, Argentina and Turkey faced
severe economic depression due to an overvalued currency.

Understanding and quantifying the reasons for a trade deficit is important. The
poor performance of a specific industry may help to bridge the gaps through the
implementation of reforms to boost production. A target-oriented industrial policy can
level the trade balance.

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