International Trade

Introduction:

International Trade is the exchange of goods and services across national boundaries

• Trade is the exchange of goods and services between two parties
• Trade is necessary because self-sufficiency is seldom possible, due to unequal distribution of Factors of Production (FOPs)
• Rationale behind specialisation and trade: To specialise in producing goods and services that one has comparative advantage in, and using these to trade for other goods and services one needs

Benefits from trade:

• Wider Consumer Choice and Greater Variety (leads to higher SOL)
• Efficiency in production and lower world prices
  • Specialisation enables firms to go beyond domestic market and reap economies of scale, especially in cases where costs of research and development are substantial
  • Lowest price of raw materials achieved, lower total price
• Factor Price Equalisation (assuming mobility of FOPs)
• Increased competition and prevention of monopolies
  • Attempts to monopolise checked by imports of cheaper products
• Innovation and transfer of technology
  • Fierce competition stimulates entrepreneurial efforts (lower cost, improve quality of output and create new products)
  • Technology transfer from advanced nations to developing countries can lead to faster economic growth
• Trade as “engine of growth”
  • Free trade provides domestic countries with greater access to global markets, stimulating growth by growing the export sector
• Non-economic advantage
  • Political, social, and cultural advantages may be gained by fostering trade links

Basis for International Trade:

Absolute Advantage: A country has absolute advantage in the production of a good when she can produce more of the good than other countries using the same amount of resources

• When reciprocal absolute advantage exists, specialisation would increase total world output

Comparative Advantage: A country has comparative advantage in the production of a good when she can produce the good at a lower opportunity cost than another country

Law of Comparative Advantage (CA):

States that (not definition) trade can benefit all countries if they specialise in the goods in which they have a comparative advantage

Assumptions:

• Only 2 countries involved in the production and  exchange of 2 commodities
• Constant opportunity costs of production of the goods
• Perfect factor mobility within each country
• Factor immobility between countries
• No transport costs, which might outweigh the benefits of specialisation and trade
• No restrictions to trade and no currency problems, so one good may be bartered easily for another
• No emergencies or political or strategic reasons for a country to produce a good with the highest comparative cost
• Each country devotes half of her resources among the production of the 2 goods

Limitations:

• Due to the law of increasing opportunity cost, a country will lose her CA with increasing specialisation, making complete specialisation not possible in the real world
• Difficult to realise the benefits of specialisation and trade due to factor immobility
• International transport costs can be very high, making it cheaper to produce in the home country than import
• Countries might produce goods without CA due to protectionism
• Sufficient differentiation of similar goods may make the products competitive worldwide

Terms of Trade (TOT):

TOT Index = (Export px index / Import px index) *100

Index will be 100 in base year

• If exports px (P_X) rise relative to import px (P_M), TOT Index rises, becomes more favourable as a given unit of export can exchange for more imports
  • Improvement effected by increase in P_X / decrease in P_M, ceteris paribus, P_X increase faster than P_M

Balance of Trade (BOT):

• Trade balance refers to the difference between the value of commodity exports and imports
• BOT = P_XQ_X – P_MQ_M = Exports revenue – Imports spending (X – M)
• +ve BOT = trade surplus, -ve BOT = trade deficit

Effect of improvement of TOT on BOT: depends on Price Elasticity of Demand (PED) for imports and exports

• P_X rises, PED_X > 1, Q_X falls >proportionately, X falls, BOT worsens
• P_X rises, PED_X < 1, Q_X falls <proportionately, X increases, BOT improves
• P_M falls, PED_M > 1, Q_M rises >proportionately, M rises, BOT worsens
• P_M falls, PED_M < 1, Q_M rises <proportionately, M falls, BOT improves

TOT effect on SOL:

• TOT improve, PED_X < 1, greater capacity to import, higher SOL, ceteris paribus
• TOT improve, PED_X > 1, smaller capacity to import, lower SOL, ceteris paribus
• TOT worsen, PED_X < 1, smaller capacity to import, lower SOL, ceteris paribus
• TOT worsen, PED_X > 1, larger capacity to import, higher SOL, ceteris paribus

Pattern of trade between Singapore and Rest of the world:

Exports: Oil, non-oil, re-exports

• Capital intensive products and services, skill-intensive electronic goods, petrochemicals, pharmaceuticals, biomedical and high income business and financial services, tourism , educational hub

Imports: Food, beverages, tobacco, crude materials, machinery equipment and electronic parts and components

Inter-industry trade: International trade in goods that belong to different industries

Intra-industry trade: International trade in goods that belong to the same / similar industries

• Proportion of trade increased recently
• Singapore now exports same finished products as it imports, producing huge quantities of a range of good for international market, reaping economies of scale
• Imports different range of same good to cater to different tastes and preferences.