International trade is the exchange of capital, goods, and services across international borders or territories because there is a need or want of goods or services. In most countries, such trade represents a significant share of gross domestic product. Trading globally gives consumers and countries the opportunity to be exposed to goods and services not available in their own countries, or which would be more expensive domestically.
The importance of international trade was recognized early on by political economists like Adam Smith and David Ricardo.Still, some argue that international trade actually can be bad for smaller nations, putting them at a greater disadvantage on the world stage.
Understanding International Trade
International trade was key to the rise of the global economy. In the global economy, supply and demand—and therefore prices—both impact and are impacted by global events.
Political change in Asia, for example, could result in an increase in the cost of labor. This could increase the manufacturing costs for an American sneaker company that is based in Malaysia, which would then result in an increase in the price charged for a pair of sneakers that an American consumer might purchase at their local mall.
Imports and Exports
A product that is sold to the global market is called an export, and a product that is bought from the global market is an import. Imports and exports are accounted for in the current account section in a country's balance of payments.
Global trade allows wealthy countries to use their resources—for example, labor, technology, or capital—more efficiently. Different countries are endowed with different assets and natural resources: land, labor, capital, and technology, etc. This allows some countries to produce the same good more efficiently—in other words, more quickly and with less of a cost. Therefore, they may sell it more cheaply than other countries. If a country cannot efficiently produce an item, it can obtain it by trading with another country that can. This is known as specialization in international trade.
For example, suppose Country A and Country B both produce cotton sweaters and wine. Country A produces ten sweaters and six bottles of wine a year, while Country B produces six sweaters and ten bottles of wine a year. Both can produce a total of 16 units. Country A, however, takes three hours to produce the ten sweaters and two hours to produce the six bottles of wine (a total of five hours). Country B, on the other hand, takes one hour to produce ten sweaters and three hours to produce six bottles of wine (a total of four hours).
Comparative Advantage
These two countries realize that they could produce more by focusing on those products with which they have a comparative advantage. Country A begins to produce only wine, and Country B begins to produce only cotton sweaters. Each country can now create a specialized output of 20 units per year and trade equal proportions of both products. As such, each country now has access to 20 units of both products.
We can see then that for both countries, the opportunity discourse of producing both products is greater than the cost of specializing. More specifically, for each country, the opportunity cost of producing 16 units of both sweaters and wine is 20 units of both products (after trading). Specialization reduces their opportunity cost and, therefore, maximizes their efficiency in acquiring the goods they need. With the greater supply, the price of each product would decrease. Thus, their choice to engage in specialization provides an advantage to the end consumer as well.
Note that, in the example above, Country B could produce both wine and cotton more efficiently than Country A. In other words, it takes Country B less time to produce both wine and cotton. This is called an absolute advantage. Country B may have this advantage because of a higher level of technology.
A product that is sold to the global market is called an export, and a product that is bought from the global market is an import. Imports and exports are accounted for in the current account section in a country's balance of payments.
Global trade allows wealthy countries to use their resources—for example, labor, technology, or capital—more efficiently. Different countries are endowed with different assets and natural resources: land, labor, capital, and technology, etc. This allows some countries to produce the same good more efficiently—in other words, more quickly and with less of a cost. Therefore, they may sell it more cheaply than other countries. If a country cannot efficiently produce an item, it can obtain it by trading with another country that can. This is known as specialization in international trade.
For example, suppose Country A and Country B both produce cotton sweaters and wine. Country A produces ten sweaters and six bottles of wine a year, while Country B produces six sweaters and ten bottles of wine a year. Both can produce a total of 16 units. Country A, however, takes three hours to produce the ten sweaters and two hours to produce the six bottles of wine (a total of five hours). Country B, on the other hand, takes one hour to produce ten sweaters and three hours to produce six bottles of wine (a total of four hours).
Comparative Advantage
These two countries realize that they could produce more by focusing on those products with which they have a comparative advantage. Country A begins to produce only wine, and Country B begins to produce only cotton sweaters. Each country can now create a specialized output of 20 units per year and trade equal proportions of both products. As such, each country now has access to 20 units of both products.
We can see then that for both countries, the opportunity discourse of producing both products is greater than the cost of specializing. More specifically, for each country, the opportunity cost of producing 16 units of both sweaters and wine is 20 units of both products (after trading). Specialization reduces their opportunity cost and, therefore, maximizes their efficiency in acquiring the goods they need. With the greater supply, the price of each product would decrease. Thus, their choice to engage in specialization provides an advantage to the end consumer as well.
Note that, in the example above, Country B could produce both wine and cotton more efficiently than Country A. In other words, it takes Country B less time to produce both wine and cotton. This is called an absolute advantage. Country B may have this advantage because of a higher level of technology.
Free Trade vs. Protectionism
As with all theories, there are opposing views. International trade has two contrasting views regarding the level of control placed on trade between countries.
Free Trade
Free trade is the simpler of the two theories. This approach is also sometimes referred to as laissez-faire economics. With a laissez-faire approach, there are no restrictions on trade. The main idea is that supply and demand factors, operating on a global scale, will ensure that production happens efficiently. Therefore, nothing needs to be done to protect or promote trade and growth, because market forces will do so automatically.
Protectionism - holds that regulation of international trade is important to ensure that markets function properly. Advocates of this theory believe that market inefficiencies may hamper the benefits of international trade, and they aim to guide the market accordingly. Protectionism exists in many different forms, but the most common are tariffs, subsidies, and quotas. These strategies attempt to correct any inefficiency in the international market.
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