Our local shopping malls and marts are packed with goods imported from countries all over the world. We are enjoying the goods made in other countries. We are also exporting canned fish, smoked fish. We are also exporting services like tourism. In fact, every one of us is doing international trade daily.
What Is International Trade?
International trade is the exchange of goods and services between countries. This type of trade gives rise to a world economy, in which prices, or supply and demand, affect and are affected by global events. Political change in Asia, for example, could result in an increase in the cost of labour, thereby increasing the manufacturing costs for an American sneaker company based in Malaysia, which would then result in an increase in the price that you have to pay to buy the tennis shoes at your local mall. A decrease in the cost of labour, on the other hand, would result in you having to pay less for your new shoes.
No country can produce everything it wants. Therefore, doing international trade helps the countries to enjoy goods and services that otherwise would not be available in the country, and thus increasing the standard of living.
International trade can happen in two ways. It is either an import or an export. When we buy good and services from abroad, we are importing those goods and services and we pay for them. When we are selling goods and services to other countries, we are exporting them and we receive payments for them.
Different countries are efficient in producing different goods and services. For example Japan and Taiwan are efficient and advanced in producing electronic goods. Certain countries are good in producing agricultural goods. Because of international trade, these countries can specialize in those goods they are best in producing.
Let’s take a simple example. Country A and Country B both produce cotton sweaters and cars. Country A produces 10 sweaters and six cars a year while Country B produces six sweaters and 10 cars a year. Both can produce a total of 16 units. Country A, however, takes three hours to produce the 10 sweaters and two hours to produce the six cars (total of five hours). Country B, on the other hand, takes one hour to produce 10 sweaters and three hours to produce six cars (total of four hours).
But these two countries realize that they could produce more by focusing on those products with which they have a comparative advantage. Country A then begins to produce only cars and Country B produces only cotton sweaters. Each country can now create a specialized output of 20 units per year and trade equal proportions of both products. As such, each country now has access to 20 units of both products.
We can see then that for both countries, the opportunity cost of producing both products is greater than the cost of specializing. More specifically, for each country, the opportunity cost of producing 16 units of both sweaters and cars is 20 units of both products (after trading). Specialization reduces their opportunity cost and therefore maximizes their efficiency in acquiring the goods they need. With the greater supply, the price of each product would decrease, thus giving an advantage to the end consumer as well.
With international trade, countries can compete in the global market. Local companies are exposed to competition from foreign companies. In addition, local companies have a wider market, allowing them to grow and become efficient. It also helps to reduce the prices of goods and services.
However, it can also be argued that competition from larger foreign companies could force the smaller local companies out of business. Therefore many governments put restrictions on international trade. This is called protectionism.
Examples of such restrictions are tariffs, quotas, and embargoes.
Theories of International Trade
1. Absolute advantage theory.
Absolute advantage says that countries should specialize in those good in which they have an absolute advantage. An absolute advantage means a country is able to produce more of a good than other countries using the same amount of resources. In this way, each country can specialize, and countries can trade with each other and enjoy greater output than they would if they opted for self-sufficiency.
2. Comparative advantage theory
The principle of comparative advantage states that a country should specialise in producing and exporting those products in which it has a comparative advantage compared with other countries and should import those goods in which it has a comparative disadvantage.
A comparative advantage means a country’s opportunity cost of producing a good or a service is lower than other countries. In this way a country can still specialize in producing a particular product even if another country enjoys absolute advantage in producing that product.
Watch the following video for a clear understanding.