International Trade

What is International Trade?

International trade is an exchange involving a good or service conducted between at least two different countries. The exchanges can be imports or exports. An import refers to a good or service brought into the domestic country. An export refers to a good or service sold to a foreign country.

International trade is a method of economic interaction between international entities and is an example of economic linkage. Other forms of economic linkages include (1) foreign financial investment, (2) multinational corporations, and (3) foreign employees. The growth in these forms of economic linkages is known as globalization.

Why Does International Trade Occur?

International trade occurs because one country enjoys a comparative advantage in the production of a certain good or service, specifically if the opportunity cost of producing that good or service is lower for that country than any other country. If a country opts not to trade with other countries, it is considered to be an autarky.

If we consider a two-country model, both countries can gain from specialization and trade. Specialization and trade will allow each country to produce the product they possess a comparative advantage in and then trade, and ultimately consume more of both goods. Therefore, there are gains from trade.

Sources of Comparative Advantage

1. International differences in climate

International differences in climate play a significant role in international trade – for example, tropical countries export products like coffee and sugar. In contrast, countries in more temperate areas export wheat or corn. Trade is also driven by differences in seasons and geography.

2. Differences in factor endowments

Differences in factor endowments imply that some countries are more resource-rich than others in land, labor, capital, and human capital. According to the Heckscher-Ohlin model, a country enjoys a comparative advantage in production if the resources are abundantly available within the country; for example, Canada exhibits a comparative advantage in the forestry industry. It is primarily driven because the opportunity cost is lower for a country rich in the related resource.

3. Differences in technology

Differences in technology are most commonly observed in superior production processes seen in different countries. For example, consider Japan in the 1970s – a country that is not overly resource-rich yet enjoys a comparative advantage in automobile manufacturing. The Japanese are able to produce more output with a given input than any other country, and it comes down to superior Japanese technology.

Examples of International Trade Policies

Most economists favor free trade agreements because of the potential for gains from trade and comparative advantage. This is because these economists believe that government intervention will reduce the efficiency of the markets. Yet, many governments introduce protectionist policies to protect domestic producers from foreign producers. There are two major protectionist policies:

1. Tariffs

A tariff is an excise that is paid on the sale of imported goods. Tariffs are put in place to discourage imports and protect domestic producers and are a source of government revenue.

A tariff raises the price received by domestic producers and the price paid by domestic consumers. Tariffs generate deadweight losses because they increase inefficiencies, as some mutually beneficial trades go unexecuted, and an economy’s resources are wasted on inefficient production.

2. Import quotas

An import quota refers to a legal limit on the quantity of a good that can be imported within a country. Generally, import quotas are administered through licensing agreements. An import quota leads to a similar result as a tariff; however, instead of generating tax revenue, the fees are paid to the license holder as quota rent.

Arguments for a Protectionist Trade Policy

The three major arguments for a protectionist trade policy are:

1. National security
2. Job creation
3. Protection of infant industries

Generally, tariffs or import quotas lead to gains for producers and losses for consumers. Therefore, the imposition of tariffs or import quotas is generally created from the political influence of the producers.

Additional Resources

Thank you for reading CFI’s guide to International Trade. To keep advancing your career, the additional CFI resources below will be useful:

• Foreign Exchange Fundamentals Course
• Non-Tariff Barriers
• Excise Tax
• North American Free Trade Agreement (NAFTA)
• Voluntary Export Restraint (VER)
• See all economics resources