LM07 International Trade and Capital Flows

Part 1

1. Introduction & International Trade-Basic Terminology

This reading will cover:

• Basic terminology used in international trade and capital flows.
• Benefits and costs of international trade.
• Trade restrictions, and the advantages of trade agreements.
• Balance of payments.
• The objectives of international trade organizations such as the World Bank and IMF that facilitate trade.

1.1 International Trade

Basic Terminology

2. Patterns and Trends in International Trade and Capital Flows

Note: There is a lot of data covered in this section in the curriculum. But, only certain testable points are highlighted here.

The following exhibits are reproduced from the curriculum. The main points are summarized below:

• Trade as a percentage of regional GDP has increased substantially all over the world in the last few decades. The developing countries in Asia experienced the fastest growth.

The exhibit below shows trade and FDI as a percentage of GDP for select countries from 1980-2007. Trade increased from 37.2% to 50.7% from 1980 to 2006.

Trade Openness and GDP Growth

Note: Averages indicate the average of the annual data for the period covered

Source: World Bank

3. Benefits and Costs of International Trade

Benefits of international trade:

• Countries gain from the exchange and specialization. For example, if one country is good at producing cloth, while another is good at manufacturing machinery, then the two countries can exchange the goods. A country benefits from exchange trade if either of the following two conditions occur in an exchange, as there is efficient allocation of resources:
  • Higher price for exports relative to selling internally.
  • Lower price for imports relative to producing internally.
• Households and firms have greater product variety. For example, after South Korean electronics manufacturers such as LG and Samsung entered the South Asian markets, consumers benefited because they have access to a wide range of products. This argument can be extended to almost any industry from automobiles to food products.
• Competition increases and resources are allocated more efficiently.
  • In an open economy, the monopoly of domestic firms reduces as competition from foreign firms increase, and forces them to be efficient. For example, automobile and steel industries exhibit increasing returns to scale.
• Industries experience greater economies of scale.
  • In an open economy, companies are forced to compete with global players and that forces them to become more efficient or go out of business. Extending the LG and Samsung example from above, economies of scale allows these firms to benefit from the larger market size in India/Middle East and experience lower average cost of production.
• Greater employment in exporting countries.
  • The garment factories in India export cotton clothing to the rest of the world for various labels. The work in this industry is labor-intensive and hence generates a lot of employment opportunities.

Note: The term “gains from trade” implies that the overall benefits of trade outweigh the losses from trade. It does not mean that all stakeholders (producers, consumers, government) benefit (or benefit equally) from trade.

Costs of international trade:

• Potential income inequality.
  • It depends on whether the industry is expanding or contracting. For example, the IT industry in the late 90’s and early 2000’s created high-paying jobs. This led to an income disparity between the IT industry and other traditional industries such as automobiles.
• Loss of jobs because less inefficient firms will be forced to exit.
  • For example, the U.S. textile industry has faced tough competition because of cheaper imports from other countries forcing many companies to exit.

Share on :