Trading is nothing but buying and selling goods and services from one another in return for a compensation levied from the buyer by the seller. The producers and consumers actively take part in trading to boost the economy. International Trade has expanded the marketplace to a global level. Goods and services are now exported and imported between countries so that consumers are presented with an assorted range of commodities and have numerous choices at their disposal when it comes to shopping or trading at a wholesale level. International trade has increased the competition in the marketplace thus ensuring that good quality products at available at reasonable rates.
When it comes to financial markets, it deals with buying and selling securities such as stock in the New York Stock Exchange (NYSE).
Let's delve into Trading
Trade involves transactions as simple as an exchange of stamps between collectors to complex international policies that define protocols to facilitate import and exports between countries. Irrespective of the type of transaction, there are there elementary type of exchanges.
International trade brings foreign products to our land which otherwise would not have been available in our country. The international market brings home a wide variety of products such as food, clothes, automobiles, spare parts, electronic gadgets, stocks, beverages etc. Alongside products, services such as tourism, banking, consulting, manufacturing, engineering, finance etc. Export deals with selling products to foreign countries while import refers to buying products from them and making it available to the citizens.
The balance of payments (BOP), summarizes all transactions such as imports and exports of goods, services, and capital that a country has made with individuals, companies, and government bodies outside the country.
Apart from the efficiency, international trade also helps in blooming global economy by fostering the growth of foreign direct investment (FDI). FDI refers to the act of a company controlling ownership of a business entity and/or assets in another country. FDI promotes economic growth allowing countries to be active economic participants. The receiving country is presented with foreign currency and expertise leading to better employment levels and thus Gross Domestic Product. When we take the investors’ perspective, company expansion and higher revenues are the returns they seek.
A negative balance of trade (BOT) can arise from a trade deficit. A country is said to be in trade deficit when revenue spent on aggregate imports exceed the revenue earned by aggregate exports. This represents an outward flow of the domestic currency to foreign countries.
Comparative Advantage: Global Trade & it's Efficiency
Global trade allows countries to use their resources be it technology, capital or labour, to their advantage. The assets and natural resources that a country own is different than its neighbours’. Due to this very reason, certain goods can be produced more efficiently in a particular country thus helping them to reap higher profits than others. It’s better to obtain an item by trading with another country if they are efficient producers of the same than oneself. This is known as specialization in international trade.
This can be illustrated with a simple example. Country A and Country B are both capable of manufacturing transistors and corn. Country A produces ten transistors and six corn cobs a year while Country B produces six transistors and ten corn cobs a year. Each country produces 16 units of both products in aggregate. It takes three hours to produce the ten transistors and two hours to produce the corn cobs (total of five hours) for Country A while Country B requires only one hour to manufacture ten transistors and three hours to gather six corn cobs (a total of four hours).
Gradually, it dawns upon these countries that they can produce more by concentrating on products over which they have a comparative advantage. Country A now specializes in corn cobs while Country B focuses on transistors. Now the aggregate output is 20 units per year for one country. They can now trade equal proportions of both products and have 10 units of each of them.
We can see that both countries benefit from specialization since its cost is less than the opportunity cost of manufacturing products. This increased profit also helps in trading and acquiring the goods required. With increased production comes a decrease in price which benefits the end consumer as well.
We observe that country B can produce both at products within 4 hours. This is called an absolute advantage, and it could be due to technological advancement. Despite absolute advantage over Country A, Country B can still reap benefits from specialization.
The law of comparative advantage can be seen in David Ricardo’s book “On the Principles of Political Economy and Taxation”. It portrays the benefits that would have been achieved by England and Portugal when specialized and traded based on their comparative advantages. Ricardo predicted that countries would gradually come to know of these facts and increase the production of the product that was more favourable for them. As the years passed by, they discovered that it was advantageous to trade and bring in products that were laborious to manufacture in one’s own country.
Another example that we can see today’s world is that cheap labour is China’s comparative advantage over the United States. Chinese workers can yield simple consumer goods at lower opportunity cost. The US specializes in capital-intensive labour thus producing sophisticated goods or investment opportunities at lower opportunity costs. China and the US thus specialize and trade along these lines so that both of them are at a comparative advantage.
This theory helps us in analysing why protectionism isn’t particularly favourable. Countries involved in international trade have partnered with suitable countries that have a comparative advantage. If a country rescinds from the trade agreement, it may produce employment opportunities in the local market. However, it is not a viable solution during the long run. Eventually, they will lose out to their neighbours who are able to produce them at a lower opportunity cost.
Scrutinizing Comparative Advantage
Despite free trade, some countries do not benefit from comparative trade as the studies predict. Rent-seeking, the process by which certain groups lobby the government to protect their personal interest, is a major reason why some countries remain rich at the expense of other countries.
Let’s take an example. The shoe manufacturers in America understand the free-trade agreement. They are also aware of the impact that cheaper foreign shoes would cause in the market. The shoe industry tries its best to stay in the market by persuading the government to provide special tax breaks for their products and/or extra duties (or even outright bans) on foreign footwear. The protectionist approach decreases the productivity of labourers and takes a toll on the consumers as well.
Free Trade Vs Protectionism
International Trade can be advocated for, depending on the level of control placed on it. A laissez-faire approach is the simpler one in which there is less involvement from the government, believing that this will pave the way to a better economy and thus society. Since supply and demand emerge on a global scale, market forces operate according to it promoting trade and growth.
Protectionism, however, mandates the regulation of international trade to promote the smooth functioning of the market. People in favour of protectionism presume that strategies such as tariffs, subsidies, and quotas are necessary for the market so that the growth is not hampered by the inefficiencies in the international market.
Currency: The Popular Medium of Exchange
Money is the accepted medium of exchange in any transaction. It is a unit of account and a store of value and can be transferred in a wide variety of ways including cash, ACH transfers, credit cards, and wired funds. Since it acts as a store of value, there is an assurance that we can use it for transactions of equivalent value in the future.
Barter system refers to cashless transactions in which goods or services are exchanged directly between parties. While it is considered as a primitive method of transaction, organizations still use it as a means to acquire goods in exchange for surplus or unutilized assets.
A good example of the barter system can be traced back to 1970s when PepsiCo Inc. set up a barter agreement with the Russian government to trade cola syrup in exchange for vodka. Later the deal was modified to include $3 billion and even 10 Russian-built ships.