Understanding International Trade and Finance
International Trade
International Commerce is the exchange of goods, services, and capital between countries. A country that participates in international trade is said to have an open economy. An indicator of a country’s degree of openness can be determined by analyzing the volume of its exports and imports relative to its GDP.
Reasons for International Trade
- Different endowments of productive resources.
- Varying technological capabilities.
- Comparative advantages in production costs.
- Differences in consumer tastes and preferences.
Advantages of International Trade
- Promotes competition, specialization, and the transmission of productivity and technology.
- Increases overall well-being.
- Encourages improvements in the quality of goods and reduces costs.
Reasons for Protectionist Measures
- To protect industries deemed strategically important to the nation.
- To promote industrialization and job creation by substituting imports with domestically manufactured products.
- To enable the development of new industries.
Types of Protectionist Measures
- Tariffs: Taxes levied on products from abroad to make them more expensive, similar to, or higher than domestic products.
- Quotas: Limits on the quantity of specific goods that can be imported.
- Export Subsidies: Aid granted to domestic manufacturers so they can export their products at more competitive prices.
- Non-tariff Barriers: Administrative regulations that affect both foreign and domestic products.
The school of thought that advocates for free trade between countries is called free trade, while the view that some level of protection is needed is called protectionism.
Balance of Payments
The Balance of Payments systematically records the economic transactions accumulated during a specific period (usually a year) between residents of a country and the rest of the world. It reflects inflows of foreign exchange as income and outflows of foreign exchange as expenditure. The balance is determined by the difference between income and payments. If income exceeds payments, there is a surplus; otherwise, there is a deficit.
1. Current Account Balance
This part of the Balance of Payments reflects purchases and sales of goods with other countries, payments made for the use of productive factors, and current transfers.
1.2. Goods Sub-balance (Trade Balance)
Reflects international trade in tangible goods.
1.3. Services Sub-balance
Reflects international service transactions.
1.4. Income Sub-balance
Records receipts and payments made using productive factors.
1.5. Transfers Sub-balance
Includes payments/receipts made without any consideration in return. It also includes payments to the EU, other organizations, and grants.
2. Capital Account Balance
Includes transfers between countries where recipient countries undertake to allocate funds to infrastructure, industries, etc.
3. Financial Account Balance
Reflects the funding a country gives to or receives from the world.
3.1. Portfolio Investment
Reflects investments in stocks, bonds, etc., in other countries to participate in profits or for other reasons.
3.2. Direct Investment
Investments made by companies or individuals in other countries to maintain a stable presence in the enterprise and participate in its management.
3.3. Reserves
These are the savings a country’s Central Bank has in foreign currency. If foreign exchange inflows are insufficient, the deficit in the current and capital account balance reduces savings.
Exchange Rate
The Exchange Rate is the value or price of one currency relative to another. When one country trades with another country with a different currency, it must exchange one currency for another, and this exchange is made in the foreign exchange market, or currency market. In this market, the supply and demand for currency determine the exchange rate.