‘Comparative advantage’, is the key to foreign trade for any country.
The concept of
comparative advantage highlights that countries that have a comparative advantage over other
countries tend to produce and export more of the goods. Foreign trade occurs when countries
exchange / export or import goods and services with other countries.
Foreign trade allows countries to use their comparative advantage for economic benefits. This
helps them grow economically and gain financial advantage. It allows countries to export goods
at comparatively higher prices and import goods at lower prices compared to the domestic
markets.
Multiple factors can drive a country’s comparative advantage:
● An abundance of natural resources: It allows export of goods that are available in
abundance.
● Robust physical assets: It allows production of goods efficiently in large quantities.
● Human capital or skilled resources: It allows production of high-quality goods.
● Political stability: It instills confidence in the importing trade partners that their orders
will not suffer because of domestic political instability.
● A large and ready consumer market: It ensures the exporters a ready market for their
goods.
A few possible drawbacks of foreign trade are noted below:
● Goods that are exported become expensive for the domestic consumers.
● The domestic industries suffer as they try to compete with cheaper imports.
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Foreign investment deals with the capital flows / investments from one country to another and the
different types of investments.
The motivation behind foreign investments are as follows:
● Financial benefit for the involved parties
● A better rate of return for the investing entity
● Economic development of the country receiving the investment
Foreign investments can be of two types: Foreign direct investment (FDI) and foreign indirect
investment (FII).
While FDIs involve setting up operations, acquiring assets or businesses in another country, FIIs or
indirect investments involve investing in shares, bonds, stock markets, or purchasing government
debts in another country.
A high FDI inflow into a country indicates good economic health and prospects for the country.
As the name suggests, trade policy governs the foreign trade. Trade policy refers to the set of
regulations and agreements that control the flow of trade between countries.
Foreign trade helps countries by enabling them to export products that they specialise in and to
import products that they do not produce.
Motivations for foreign trade:
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● Support local employment opportunities: By decreasing imports from cheap labour
abroad, domestic jobs are protected
● Protect infant or nascent industries: Protecting such industries from foreign competition
● Counter-aggressive trade policies: Retaliating to hostile trade policies of other countries,
for example, anti-dumping duties
● Generate extra revenues: Imposing additional taxes and duties on imported goods
Although foreign trade is beneficial for countries, governments impose trade barriers to restrict
the flow of trade with some countries.
Trade barriers are of two types: Tariff barriers and non-tariff barriers.
Free trade agreements (FTAs) are agreements between two or more countries regarding how
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trade should flow among them. Overall, the outcome of FTAs should be increased trade and wealth
for all participating countries.
Balance of payments (BOP) is the recorded summary of all the financial transactions performed by
the entities of a country with the rest of the world over a defined period of time.
The balance of payment segregates these transactions into two components:
1. Current account:
a. It reflects a country’s net income or net spending through trade.
b. It includes all the exports and imports, interest payments on international
investments, and transfer payments, including international remittances.
c. The transactions are recorded in real time.
2. Capital account:
a. It reflects all the international sales and purchase of assets, such as purchases of
government debt, bonds or foreign direct investment.
Another important concept is the balance of trade (BOT), which refers to the difference between
the value of a country’s exports and imports for a given period of time.
● If the value of a country's exports exceeds that of the imports, then the country is said to
have a trade surplus.
● In contrast, if the value of imports exceeds that of the exports, then the country is said to
have a trade deficit.
The balance of trade (BOT) is the difference between the value of imports and exports of material
goods (tangibles) only, whereas the balance of payments (BOP) is the difference between a
country's receipts and payments in foreign exchange (both tangibles and intangibles). This is the
reason why BOT is a part of a country's BOP.
When a country’s current account reflects a surplus or deficit, its balance of payments is said to
be in disequilibrium.
Governments can correct the disequilibrium in their BOP through various measures such as
lowering imports, increasing exports and controlling inflation levels in the economy.
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As governments can impose trade barriers, it is important to understand why they would do so.
Future trade barriers can be better predicted by deducing the potential reasons for imposing
these barriers. They can help to indicate potential trade barriers in the future but also pose risks.
Primarily, organisations face two types of international risks:
● The economic risk to a business is the possibility that the host economy faces a downturn.
● The political risk is a threat to the business landscape surfacing from the political realm.
The different ways to mitigate political risks would include diversification of the portfolio, buying
political risk insurance, hiring analysts to analyse political risks, and so on.
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