International Trade | NEB Class 12 Economics

International Trade

The transaction of goods & services between countries is called international trade.

Role or Importance of International Foreign Trade

1. Proper utilization of resources

Through international trade, nations specialize in producing those goods in which they have a greater comparative advantage consequently, each every country always tries to allocate the available resources properly & efficiently.

2. Benefits to consumer

Foreign goods, which are not produced domestically because of the higher production cost & other reasons are easily accessible in the international market. So, the consumer can take & enjoy by consuming them in both least cost & high quality.

3. Increase in employment & income

International trade does not provide only goods & services but it also increases income of the people along with the increase in employment opportunities in the nation. More goods are demanded in the international market. It creates more employment there by more income earning opportunities.

4. Economic development

Due to international trade, the countries will be producing exporting the goods which have comparative advantage, demanded in the foreign market. As a result, demand for labour increases, so people can get employment their income in areas. Also the existing resources will be fully efficiently utilized. Then, the overall economy of a nation will be improved.

5. Good relation with foreign countries

International trade helps to build up good relation with foreign countries in the international market. Having a good relation with efficiency capacity & economic condition in the world.

6. Improvement in living standard of people

All the people of the world have modern high standard life due to international trade. International trade helps for industrialization creates employment opportunities thus increase the living standard of people. In the absence of international trade, the world would have to remain primitive.

7. Cheaper & quality product

Goods imported from efficient countries can be provided to citizens at lower prices. Similarly, goods efficiently produced within the country can be exported abroad. Thus, international trade makes qualitative cheaper goods available to public.

8. Increase in government revenue

International trade promotes industrial development which leads to increase in production. With the increase in production, the revenue of the government increases because the government imposes different types of taxes like VAT, excise duty, etc. On the other hand, the government also receives revenue imposing tariff (tax on import) & export tax.

Measure to Reduce Trade Deficit

1. Establishment of large scale industries

Nepal should establish sufficient number of large scale industries like chemical fertilizers, automobiles companies, textile industries, rubber industries, agro-based industries, fruits processing industries, paper, sugar, steel & iron industries & so on. The products produced by many large scale industries reduces the imports. It helps to minimize the trade deficit.

2. Reducing the cost of production

The cost of production of Nepalese goods are comparatively more expensive than foreign goods. So, Nepal's should use modern technique production to minimize the costs of production. We should produce goods & services in large scale in order to reduce the average cost of production.

3. Controlling illegal trade between Nepal & India

Geographically, Nepal is surrounded by India from three sides & China from North side. More than 60% of Nepal's foreign trade is concentrated with India. Due to open border, illegal trade takes place between two countries. So, Nepal government should give special focus to control illegal trade between India & Nepal.

4. Using the alternative means of energy

One of the most expensive item that Nepal imports is the petroleum product. So, its import is increasing day by day (thereby trade deficit). Thus, Nepal should identify use alternative means of energy like: electricity & solar energy.

5. Conducting research for exporting to new destinations & new products

Nepal imports most of the luxurious expensive commodities from more than 100 countries' exports very few primary products to a few countries. So, we should conduct research to identify new destinations for Nepalese products. Hence, we should produce an export more verities of products in world market.

6. Increasing productivity & types of products

The production capacity of Nepalese industries is very low. So, the production capacity should be increased are produced in Nepal & maximum are imported. So, policies & focus should be given towards the increasing the types of products. It substitutes for import & reduces the trade deficit.

7. Using alternative means of transportation

Nepal is using road transport to import & export goods. It is very expensive means of transportation. So, in order to minimize the transit cost, we should use alternative means of transport: like railway transport to carry goods, Pipe lines for petroleum products, at large quantity in lower transport cost.

8. Managing sufficient amount of capital for investment

Nepal is one of the developing country with low per capita income. On the one side the rate of capital formation is low of thus, less amount is available for investment. On the other side, the available capital is used in unproductive sectors. So, available capital should be used only in productive sectors.

Differences between BOT & BOP

Balance of Trade

Trade balance is the difference between exports & imports of visible material goods. It is also known as the net export which is a difference between the value of country's export & the value of its import

Types of balance of trade

Balance of trade can be dividend into the following three types:

1. Trade surplus

If the total export of a country exceeds its total import, it is called trade surplus. It is also known as the favourable trade balance. Trade surplus: export(X) > Import(M)

2. Trade deficit

If the total import of a country exceeds its total export, it is called trade deficit. It is also known as the unfavourable trade balance or adverse balance of trade. Trade Deficit: Import(M) > Export(X)

3. Balanced trade balance

If the export & the import of a country are equal, it is called balanced trade balance. It is also known as the equilibrium in balance of trade. Balanced trade Balance: Export $$ (x)=\text{Import}(M) $$

Balance of Payment (BOP)

A comprehensive record of economic transactions of a country with the rest of the world during a given period of time is called BOP. It includes the trade of visible as well as invisible items. It adopts double entry book keeping system, it has two sides: credit side & debit side. All payments to be received from abroad are recorded on the debit side & all payments to be made to the foreigners are included on the credit side.

Types of Balance of Payment

There are two types of balance of payment account which are as follows:

1. Favourable balance of payment

If the total receipts of a country exceed its total payments it is called favourable balance of payment. It is also known as the surplus of the balance of payment. Favourable Balance of Payment: Total Receipts > Total Payments

2. Unfavourable balance of payment

If the total payments a country exceeds its total receipts, it is called unfavourable balance of payment. It is also known as the deficit of the balance of payment. Unfavourable Balance of Payment: Total Receipts < Total Payments

Foreign Exchange Rate

It is the price of a currency in terms of another currency. Simply it is the amount of one country's currency that is required to purchase one unit of another country's currency. The foreign currencies are exchanged or transferred in foreign exchange market.

Types of exchange rate

1. Flexible exchange rate

The flexible exchange rate system is one in which rates of currency or exchange rate is determined by the market forces of demand & supply. It is also known as the floating exchange rate system. In the flexible exchange rate system, government does not make any kind of interference. For example, the exchange rate system between Nepal USA is flexible exchange rate. Most of the countries of the world have adopted flexible exchange rate system.

2. Fixed exchange rate

The fixed exchange rate system is one in which rate of currency or exchange rate is fixed in terms of another currency. This is also known as the pegged exchange rate system. It does not fluctuate with change in demand & supply of foreign currency. The exchange rate system between Nepal & India is fixed exchange rate system.

Free Trade & Protectionism

Free Trade

It is the international exchange of goods & services without any restrictions or barriers. In other words, free trade refers to free trade such as tariffs, quotas licensing system etc., are absent. There is no distinction unrestricted movement of goods & services between different countries in the world. Under the free trade policy, all kinds of artificial controls on international trade such as tariffs, quotas licensing systems are absent. Under this trade system, the government does not impose tariffs & 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 & services in which it has maximum profit. Therefore, every country devotes itself to produce those goods by using the resources fully & efficiently.

2. Maximum output

Due to free trade policy, a country specializes in the basis of division of labour. As a result, productive capacity increases. The country can produce more & more goods & services. Output will be maximum because of higher scope of market.

3. Benefit to consumers

Free trade enables consumers to have high quality commodities at lower cost. Since every country produces only those goods that can be produced at least cost in good quality other countries import such goods from these available to consumers at cheaper prices.

4. Benefit to producers (market expansion)

It widens the market for producers from domestic to international region. Producers can produce & more quantities & varieties of goods & services. They can earn more profit because of market expansion.

5. Technological improvement

In order to trade & compete in international market producers are compelled to produce quality goods at minimum cost, modern cost reducing technology becomes necessary. This changes improves every country to endeavor to bring about technological improvement that economizes cost & enhances quality.

6. Creates international relation

Due to free trade policy it makes good relation among its trading partners & creates cooperation 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. the new industries of developing countries like Nepal. Such infant industries cannot complete with the industries of developed nations in terms of price, quality & quantity.

2. Unhealthy competition

In free trade, each every country is increased export if there is excess. It invites unhealthy competition among the countries because industries established in underdeveloped countries are not able to complete with those established in developed ones.

3. Creates dependency

Due to the one-sided or imbalanced industrial development in the economy, it increases dependency of developing countries on developed countries ultimately it reduces economic development developing countries always depend upon developed countries for goods & services.

4. Possibility of unemployment

Under free trade, developing countries are compelled to compete with other countries in international market by adopting cost minimizing technology & such technology generally tends to be capital intensive. It, therefore replaces labour by machines' unemployment exists if it will be widespread.

5. Harmful to underdeveloped countries

Free trade policy is harmful to underdeveloped countries because such countries are unable to compete with developed countries because of the existing resources, production technology, cost of production quality of products. Hence it leads to international domination. Similarly, they are unable to protect their infant industries.

6. Trade of harmful products

Commodities are easily exported & imported under free trade policy. There may be high chance to trade socially restricted or injurious or harmful goods in order to earn more profit by business sector.

Protection Trade or Protectionism

Protection refers to the policy of encouraging home industries by giving subsidies to home products & imposing duties on foreign goods by raising their prices relative to those of domestically produced goods. This system enables domestic products to be in discrimination between domestically foreign produced goods.

Under the protection trade policy in the world, two types of instruments are used to protect domestic industries. They are tariff barriers & non-tariff barriers. In the tariff barriers, government imposed high custom duties on imported goods to make them relatively more expensive than domestic products. Similarly, under the non-tariff barriers, government controls import by giving subsidy in domestic products by applying quota system exchange control etc.

Advantages of Protection Policy

1. Development of infant industries

Infant industries are not strong to compete with the long-established foreign industries. The operational cost of such industries is very high. They need protection to be able to stand in competition against grown-up industries of industrially advanced countries.

2. Development of basic & large scale industries

In the protection trade policy imports of foreign goods are controlled by the government & domestic producers are compelled to produce those goods. As a result, it helps to develop basic & large-scale industries.

3. Proper utilization of resources

Domestic producers should produce most of the necessary goods in this trade policy. This, existing resources are fully efficiently utilized to fulfill the demand of domestic countries.

4. Creates employment opportunities

This policy creates opportunities for employment. When industries are granted protection, they expand & progress. Skilled semi-skilled & unskilled labour obtain addition opportunities for gainful employment.

5. Self sufficiency

Due to the protection trade policy, produces of the countries produce almost all types of goods & services in the nation. It increases self suiticiency & the country may become economically independent.

6. Reduces supply of domestic currency

The protection policy encourages its citizens to keep money or wealth at home by consuming domestic products. When a country imports from abroad it is people get goods from the foreigners get money

Disadvantages of Protection

1. Creation of monopolies

Due to the protection policy, there is not any kind of competition in the domestic market. As a result, it consolidates the home industries to make monopoly power in the economy by providing abundant opportunities.

2. Loss to consumer

Because of protection policy, the price of domestic goods is high. There is total absence of foreign goods in the market. The consumers have to pay higher prices for such goods.

3. Decrease in competitive capacity

Under this policy, the protected industry becomes dependent upon the government & its policy. They start taking things easy & do not develop competitive capacity. They tend to remain in funds forever. They cannot develop their competitive capacity in terms of price, quality & quantity with other countries.

4. No equal distribution of income

Under this policy, special facilities are provided only to rich people who are the producers. They become richer because of high profit floor or consumers become poor because of higher prices. It ultimately increases the disability between them in the society.

5. Reduces foreign relation

Protection may reduce relation between various countries in international market. When a country reduces its import through policy of protection, another country may also use the same policy for its betterment. As a result, it does not make good relations among the countries.

Comparative Cost Theory of International Trade

The comparative cost theory of international trade was propounded by the classical economic. David Ricardo in 1817. This theory is based on the difference in the cost of production of similar goods in different countries. The cost of production of a commodity may differ from country to country because of various reasons like climate, natural resources, geographical situation, efficiency of labour, etc. Thus, each country is specialized to produce such goods in which the comparative cost of production is the least. In other words, a country is specialized in the production of such goods in which it has greater comparative advantages or the least comparative disadvantage with other countries on the basis of the cost of production.

This theory is based on the following assumptions.

1. There are only two countries & two commodities.
2. Both countries produce similar goods.
3. Labour is only the factor of production.
4. Cost of production is measured in terms of labour.
5. Production technology remains constant.
6. There is perfect competition in both product & factor markets.
7. There is free trade among the countries.
8. There is no transportation cost.

We can explain the comparative cost theory of International trade on the basis of above assumptions. The following table helps to explain the comparative cost theory of international trade:

According to above table, India needs 4 labour hours to produce 1 kg cotton. 2 labour hours to produce 1 kg jute. On the other hand, Nepal needs 15 labour hours to produce 1 kg cotton. 5 labour hours to produce 1 kg Jute. Thus, India has absolute advantage in the production of both goods: cotton, jute. In other words, India can produce both goods at the lower cost than Nepal. Now, question arises, whether Nepal should not produce both goods or Nepal should import both goods from India. But according to Ricardian Comparative Cost Theory of International Trade, both countries will gain if they produce according to comparative cost advantage. From the table, it is clear that India's opportunity cost of producing 1 kg cotton is 2 kg jute. & Nepal's opportunity cost of producing 1 kg cotton in 3 kg Jute. By comparing the opportunity cost of producing 1 kg cotton, India has lower internal opportunity cost than Nepal. Hence, India has comparative cost advantage in the production of cotton. Similarly, India's opportunity cost of producing 1 kg jute is $$\frac{1}{2}$$ kg cotton. & Nepal's opportunity cost of producing 1 kg jute is $$\frac{1}{3}$$ kg cotton.

Comparing the opportunity cost of producing 1 kg jute. Nepal has lower opportunity cost than India. Hence, Nepal has comparative cost advantage in the production of jute.

In this situation, if Nepal specializes in the production of jute & India specializes in the production of cotton, both countries will gain from the international trade. In other words, Nepal should export jute to India & import cotton from India & India should import jute from Nepal & export cotton to Nepal to gain from the international trade.

Criticisms of the Comparative Cost Theory of International Trade

The Comparative Cost Theory of International Trade is criticized as follows:

1. This theory is based on the concept of two countries exchanging only two goods. In reality, international trade takes place between many countries many commodities.
2. This theory assumes that labour is the only factor of production, fall the other factors of production are neglected. The assumption of homogeneous labour is also unrealistic.
3. This theory assumes that specialization is followed by constant returns to scale. But in reality the cost of production does not remain constant with the increasing level of output.
4. In this theory, transportation cost is ignored for the determination of comparative advantage. This is highly unrealistic because it plays an important role in the development of international trade.
5. This theory assumes that the factors of production are perfectly mobile within the country. But in reality, when there is more specialization, there is less mobility of factors. When there is difficulty of transfer of factors, the cost of production is affected.