International trade is exchange of capital, goods, and services across international borders or territories. In most countries, it represents a significant share of gross domestic product (GDP). While international trade has been present throughout much of history (see Silk Road, Amber Road), its economic, social, and political importance has been on the rise in recent centuries.
Industrialization, advanced transportation, globalization, multinational corporations, and outsourcing are all having a major impact on the international trade system. Increasing international trade is crucial to the continuance of globalization. Without international trade, nations would be limited to the goods and services produced within their own borders.
International trade is in principle not different from domestic trade as the motivation and the behavior of parties involved in a trade do not change fundamentally regardless of whether trade is across a border or not. The main difference is that international trade is typically more costly than domestic trade. The reason is that a border typically imposes additional costs such as tariffs, time costs due to border delays and costs associated with country differences such as language, the legal system or culture.
Another difference between domestic and international trade is that factors of production such as capital and labour are typically more mobile within a country than across countries. Thus international trade is mostly restricted to trade in goods and services, and only to a lesser extent to trade in capital, labor or other factors of production. Then trade in goods and services can serve as a substitute for trade in factors of production. Instead of importing a factor of production, a country can import goods that make intensive use of the factor of production and are thus embodying the respective factor. An example is the import of labor-intensive goods by the United States from China. Instead of importing Chinese labor the United States is importing goods from China that were produced with Chinese labor.
International trade is also a branch of economics, which, together with international finance, forms the larger branch of international economics.
Several different models have been proposed to predict patterns of trade and to analyze the effects of trade policies such as tariffs.
The Panama Canal is important for international sea trade between the Atlantic Ocean and the Pacific Ocean.
The Ricardian model focuses on comparative advantage and is perhaps the most important concept in international trade theory. In a Ricardian model, countries specialize in producing what they produce best. Unlike other models, the Ricardian framework predicts that countries will fully specialize instead of producing a broad array of goods.
Also, the Ricardian model does not directly consider factor endowments, such as the relative amounts of labor and capital within a country. The main merit of Ricardin model is that it assumes technology differences between countries. Technology gap is easily included in the Ricardian and Ricardo-Sraffa model (See the next subsection).
The Ricardian model makes the following assumptions:
1. Labor is the only primary input to production (labor is considered to be the ultimate source of value).
2. Constant Marginal Product of Labor (MPL) (Labor productivity is constant, constant returns to scale, and simple technology.)
3. Limited amount of labor in the economy
4. Labor is perfectly mobile among sectors but not internationally.
5. Perfect competition (price-takers).
The Ricardian model measures in the short-run, therefore technology differs internationally. This supports the fact that countries follow their comparative advantage and allows for specialization.
The Ricardian trade model was studied by Graham, Jones, McKenzie and others. All the theories excluded intermediate goods, or traded input goods such as materials and capital goods. McKenzie(1954), Jones(1961) and Samuelson(2001)emphasized that considerable gains from trade would be lost once intermediate goods were excluded from trade. In a famous comment McKenzie (1954, p. 179) pointed that "A moment's consideration will convince one that Lancashire would be unlikely to produce cotton cloth if the cotton had to be grown in England."
Recently, the theory was extended to the case that includes traded intermediates. Thus the "labor only" assumption (#1 above) was removed from the theory. Thus the new Ricardian theory, or the Ricardo-Sraffa model, as it is sometimes named, theoretically includes capital goods such as machines and materials, which are traded across countries. In the time of global trade, this assumption is much more realistic than the Heckscher-Ohlin model, which assumes that capital is fixed inside the country and does not move internationally.
In the early 1900s an international trade theory called factor proportions theory emerged by two Swedish economists, Eli Heckscher and Bertil Ohlin. This theory is also called the Heckscher-Ohlin theory. The Heckscher-Ohlin theory stresses that countries should produce and export goods that require resources (factors) that are abundant and import goods that require resources in short supply. This theory differs from the theories of comparative advantage and absolute advantage since these theory focuses on the productivity of the production process for a particular good. On the contrary, the Heckscher-Ohlin theory states that a country should specialise production and export using the factors that are most abundant, and thus the cheapest. Not to produce, as earlier theories stated, the goods it produces most efficiently.
The Heckscher-Ohlin model was produced as an alternative to the Ricardian model of basic comparative advantage. Despite its greater complexity it did not prove much more accurate in its predictions. However from a theoretical point of view it did provide an elegant solution by incorporating the neoclassical price mechanism into international trade theory.
The theory argues that the pattern of international trade is determined by differences in factor endowments. It predicts that countries will export those goods that make intensive use of locally abundant factors and will import goods that make intensive use of factors that are locally scarce. Empirical problems with the H-O model, known as the Leontief paradox, were exposed in empirical tests by Wassily Leontief who found that the United States tended to export labor intensive goods despite having a capital abundance.
The H-O model makes the following core assumptions:
1. Labor and capital flow freely between sectors
2. The production of shoes is labor intensive and the production of computers is capital intensive
3. The amount of labor and capital in two countries differ (difference in endowments)
4. Free trade
5. Technology is the same across countries (long-term)
6. Tastes are the same.
The problem with the H-O theory is that it excludes the trade of capital goods (including materials and fuels). In the H-O theory, labor and capital are fixed entities endowed to each country. In a modern economy, capital goods are traded internationally. Gains from trade of intermediate goods are considerable, as it was emphasized by Samuelson (2001).
Reality and Applicability of the Heckscher-Ohlin Model
The Heckscher-Ohlin theory is preferred to the Ricardo theory by many economists, because it makes fewer simplifying assumptions. In 1953, Wassily Leontief published a study, where he tested the validity of the Heckscher-Ohlin theory. The study showed that the U.S was more abundant in capital compared to other countries, therefore the U.S would export capital- intensive goods and import labour-intensive goods. Leontief found out that the U.S's export was less capital intensive than import.
After the appearance of Leontief's paradox, many researchers tried to save the Heckscher-Ohlin theory, either by new methods of measurement, or either by new interpretations. Leamer emphasized that Leontief did not interpret HO theory properly and claimed that with a right interpretation paradox did not occur. Brecher and Choudri found that, if Leamer was right, the American workers consumption per head should be lower than the workers world average consumption.
Many other trials followed but most of them failed. Many of famous textbook writers, including Krugman and Obstfeld and Bowen, Hollander and Viane, are negative about the validity of H-O model. After examining the long history of empirical research, Bowen, Hollander and Viane concluded: "Recent tests of the factor abundance theory [H-O theory and its developed form into many-commodity and many-factor case] that directly examine the H-O-V equations also indicate the rejection of the theory."
Heckscher-Ohlin theory is not well adapted to the analyze South-North trade problems. The assumptions of HO are less realistic with respect to N-S than N-N (or S-S) trade. Income differences between North and South is the one that third world cares most. The factor price equalization [a consequence of HO theory] has not shown much sign of realization. HO model assumes identical production functions between countries. This is highly unrealistic. Technological gap between developed and developing countries is the main concern of the poor countries.
Current members of the World Trade Organisation.
Global Competitiveness Index (2008-2009): competitiveness is an important determinant for the well-being of states in an international trade environment.
In this model, labor mobility between industries is possible while capital is immobile between industries in the short-run. Thus, this model can be interpreted as a 'short run' version of the Heckscher-Ohlin model. The specific factors name refers to the given that in the short-run, specific factors of production such as physical capital are not easily transferable between industries. The theory suggests that if there is an increase in the price of a good, the owners of the factor of production specific to that good will profit in real terms.
Additionally, owners of opposing specific factors of production (i.e. labor and capital) are likely to have opposing agendas when lobbying for controls over immigration of labor. Conversely, both owners of capital and labor profit in real terms from an increase in the capital endowment. This model is ideal for particular industries. This model is ideal for understanding income distribution but awkward for discussing the pattern of trade.
New Trade Theory
New Trade theory tries to explain several facts about trade, which the two main models above have difficulty with. These include the fact that most trade is between countries with similar factor endowment and productivity levels, and the large amount of multinational production(i.e.foreign direct investment) which exists. In one example of this framework, the economy exhibits monopolistic competition and increasing returns to scale. There are three basic theories that global marketer has to comprehend: 1. Comparative Advantage Theory 2. Trade or product trade cycle theory 3. Business orientation theory
Gravity model of trade
The Gravity model of trade presents a more empirical analysis of trading patterns rather than the more theoretical models discussed above. The gravity model, in its basic form, predicts trade based on the distance between countries and the interaction of the countries' economic sizes. The model mimics the Newtonian law of gravity which also considers distance and physical size between two objects. The model has been proven to be empirically strong through econometric analysis. Other factors such as income level, diplomatic relationships between countries, and trade policies are also included in expanded versions of the model.
Top trading nationsRank? Country? Exports + Imports? Date of information?
- European Union (Extra-EU27) $3,197,000,000,000 2009
1 United States $2,439,700,000,000 2009 est.
2 Germany $2,209,000,000,000 2009 est.
3 People's Republic of China $2,115,500,000,000 2009 est.
4 Japan $1,006,900,000,000 2009 est.
5 France $989,000,000,000 2009 est.
6 United Kingdom $824,900,000,000 2009 est.
7 Netherlands $756,500,000,000 2009 est.
8 Italy $727,700,000,000 2009 est.
- Hong Kong $672,600,000,000 2009 est.
9 South Korea $668,500,000,000 2009 est.
10 Belgium $611,100,000,000 2009 est.
11 Canada $603,700,000,000 2009 est.
12 Spain $508,900,000,000 2009 est.
13 Russia $492,400,000,000 2009 est.
14 Mexico $458,200,000,000 2009 est.
15 Singapore $454,800,000,000 2009 est.
16 India $387,300,000,000 2009 est.
17 Taiwan $371,400,000,000 2009 est.
18 Switzerland $367,300,000,000 2009 est.
19 Australia $322,400,000,000 2009 est.
20 United Arab Emirates $315,000,000,000 2009 est.
Regulation of international trade
Traditionally trade was regulated through bilateral treaties between two nations. For centuries under the belief in mercantilism most nations had high tariffs and many restrictions on international trade. In the 19th century, especially in the United Kingdom, a belief in free trade became paramount. This belief became the dominant thinking among western nations since then. In the years since the Second World War, controversial multilateral treaties like the General Agreement on Tariffs and Trade (GATT) and World Trade Organization have attempted to promote free trade while creating a globally regulated trade structure. These trade agreements have often resulted in discontent and protest with claims of unfair trade that is not beneficial to developing countries.
Free trade is usually most strongly supported by the most economically powerful nations, though they often engage in selective protectionism for those industries which are strategically important such as the protective tariffs applied to agriculture by the United States and Europe. The Netherlands and the United Kingdom were both strong advocates of free trade when they were economically dominant, today the United States, the United Kingdom, Australia and Japan are its greatest proponents. However, many other countries (such as India, China and Russia) are increasingly becoming advocates of free trade as they become more economically powerful themselves. As tariff levels fall there is also an increasing willingness to negotiate non tariff measures, including foreign direct investment, procurement and trade facilitation. The latter looks at the transaction cost associated with meeting trade and customs procedures.
Traditionally agricultural interests are usually in favour of free trade while manufacturing sectors often support protectionism.This has changed somewhat in recent years, however. In fact, agricultural lobbies, particularly in the United States, Europe and Japan, are chiefly responsible for particular rules in the major international trade treaties which allow for more protectionist measures in agriculture than for most other goods and services.
During recessions there is often strong domestic pressure to increase tariffs to protect domestic industries. This occurred around the world during the Great Depression. Many economists have attempted to portray tariffs as the underlining reason behind the collapse in world trade that many believe seriously deepened the depression.
The regulation of international trade is done through the World Trade Organization at the global level, and through several other regional arrangements such as MERCOSUR in South America, the North American Free Trade Agreement (NAFTA) between the United States, Canada and Mexico, and the European Union between 27 independent states. The 2005 Buenos Aires talks on the planned establishment of the Free Trade Area of the Americas (FTAA) failed largely because of opposition from the populations of Latin American nations. Similar agreements such as the Multilateral Agreement on Investment (MAI) have also failed in recent years.
Risk in international trade
Companies doing business across international borders face many of the same risks as would normally be evident in strictly domestic transactions. For example,
* Buyer insolvency (purchaser cannot pay);
* Non-acceptance (buyer rejects goods as different from the agreed upon specifications);
* Credit risk (allowing the buyer to take possession of goods prior to payment);
* Regulatory risk (e.g., a change in rules that prevents the transaction);
* Intervention (governmental action to prevent a transaction being completed);
* Political risk (change in leadership interfering with transactions or prices); and
* War and other uncontrollable events.
In addition, international trade also faces the risk of unfavorable exchange rate movements (and, the potential benefit of favorable movements).