International Trade: Fundamentals and Framework
International Trade Fundamentals
International trade makes it possible for all parties involved to obtain benefits. The main advantage of trade is that it enables countries to specialize in the production of goods and services in which they are able to produce better. This leads the country to allocate its factors to activities with high productivity in relative terms and, as a consequence, possibilities of consumption are expanded. The greater relative availability of one or more factors of production is one of the main sources of comparative advantage, especially in the case of primary goods exports.
The Heckscher-Ohlin theorem states that countries tend to specialize in the production and export of those goods that are more intensive in the factor that is more abundant (or cheapest), while imports are more intensive in the factor that is increasingly scarce (or expensive). This is based on the assumption that there’s no international mobility of factors of production and all countries share the same technological level. The price of each factor depends on its relative endowment and the demand for it.
The Stolper-Samuelson theorem indicates that, when the price of a good rises, production will experience a higher remuneration (in the country where it is more abundant), while in other countries both demand and price will decrease. This trend will continue until a point where the prices employed in the factor of production would converge between the different countries and competition will try to replace the expensive factors with factors that become cheaper. The problem that arises is that it takes long and expensive processes to adapt their relative prices.
Countries, in most of their international trade flows, tend to export and import goods from the same industries; this is called intra-industry trade. This behavior can be explained since consumers have similarities in tastes regardless of their country of residence and that economies of scale appear. As a result, companies specialize in certain types of products or even in parts of the production process, obtaining competitive advantages.
The rise of international trade can also be explained by the differences in the technological level of countries. Vernon’s theory of product cycle explains that the most advanced countries are those which generally create the most innovative products and export them to the rest of the world. In the first stage, they make large profits, arising from the temporary monopoly power, up to a moment at which these products may be manufactured in other countries (imitation) at lower costs.
Arguments for Protectionist Measures
- To protect strategic industries for national security reasons.
- To protect infant industries.
- To avoid Balance of Payments crises.
- To promote national employment, replacing imports with domestic production.
- To protect from unfair foreign competition.
- To deal with social dumping.
Protectionist Measures
Protectionist measures can adopt different forms:
- Tariffs: Taxes applied to imported goods. They can be specific (there’s a fixed amount on each physical product imported) or ad valorem (there’s a percentage of the value of the imported good). Consequence: increase in domestic production and government revenue. Benefit: they harm consumers who are forced to pay a higher price.
- Quotas: Limitations on the maximum amount to be imported.
- Non-tariff barriers and other obstacles: Administrative measures often attempt to hamper the entry of foreign products. Instruments like sanitary requirements, rules to protect consumers or the environment, etc.
Institutional Framework for International Trade
GATT (General Agreement on Tariffs and Trade) 1947: Signed to promote trade liberalization in a multilateral way. It was an international agreement whereby the countries that had adhered to it (initially 27, currently 161) committed themselves to comply with tariff agreements within a framework of multilateralism, and to maintain trade policies respecting some rules and principles, such as not engaging in dumping or not subsidizing exports. Main objective: to gradually liberalize international trade and establish “good trade behavior” and sanctions in case of non-compliance. In its early days, the agreement focused on industrial products. Until the Uruguay Round (1993), textiles, agricultural products, and services were excluded from the agreement.
The GATT has liberalized international trade through “negotiating rounds.” Principles:
- Reciprocity: Articulates tariff reductions on the basis of equivalent concessions.
- Non-discrimination: The tariff reductions granted to a third country must be extended to the rest of the countries adhering to the agreement.
- Transparency: Non-tariff barriers must not be increased under any circumstances and should be replaced by tariff barriers.
- Free trade: Prohibits practices which may distort the proper functioning of international trade, such as dumping or subsidies.
- Consolidation: Countries pledge not to raise tariffs in the future.
In addition to trade in goods, the WTO has worked on the liberalization of trade in services, aiming to liberalize them. The frame of the liberalization of services is called the GATS (General Agreement on Trade in Services).
TRIPS (General Agreement on Intellectual Property Rights): Attempts to establish a general framework for the protection of these rights at the international level.
The purpose is to discourage copies, fakes, and forgeries which reduce incomes obtained from innovation. The Uruguay Round has begun to liberalize trade in agricultural and textile products by replacing non-tariff barriers with tariffs and reducing service and intellectual property rights. The institution responsible for promoting trade liberalization is the WTO (World Trade Organization), which was established as a result of the Uruguay Round agreements. Among its functions, we can also mention: managing multilateral trade agreements, resolving trade disputes, and monitoring countries’ trade policies.
UNCTAD (United Nations Conference on Trade and Development): International institution created in 1964 whose main task is to contribute to the development of the poorest countries through international trade. Its main regulatory organ is the Conference, which meets every four years, while its governing body is the Board, which meets three times a year. Its technical cooperation focuses on human and institutional training and its main achievement has been the introduction of the GSP (Generalized System of Preferences) in 1971.