Foreign Trade

Foreign Trade, the exchange of goods and services between nations. Goods can be defined as finished products, as intermediate goods used in producing other goods, or as agricultural products and foodstuffs. International trade enables a nation to specialize in those goods it can produce most cheaply and efficiently. Trade also enables a country to consume more than it would be able to produce if it depended only on its own resources. Finally, trade enlarges the potential market for the goods of a particular economy. Trade has always been the major force behind the economic relations among nations.

II

EMERGENCE OF MODERN FOREIGN TRADE

Although foreign trade was an important part of ancient and medieval economies, it acquired new significance after about 1500. As empires and colonies were established by European countries, trade became an arm of governmental policy. The wealth of a country was measured in terms of the goods it possessed, particularly gold and precious metals. The objective of an empire was to acquire as much wealth as possible in return for as little expense as possible. This form of international trade, called mercantilism, was commonplace in the 16th and 17th centuries.

International trade began to assume its present form with the establishment of nation-states in the 17th and 18th centuries. Heads of state discovered that by promoting foreign trade they could mutually increase the wealth, and thus the power, of their nations. During this period new theories of economics, in particular of international trade, also emerged.

III

ADVANTAGES OF TRADE

In 1776 the Scottish economist Adam Smith, in The Wealth of Nations, proposed that specialization in production leads to increased output. Smith believed that in order to meet a constantly growing demand for goods, a country's scarce resources must be allocated efficiently. According to Smith's theory, a country that trades internationally should specialize in producing only those goods in which it has an absolute advantage—that is, those goods it can produce more cheaply than can its trading partners. The country can then export a portion of those goods and, in turn, import goods that its trading partners produce more cheaply. Smith's work is the foundation of the classical school of economic thought.

Half a century later, the English economist David Ricardo modified this theory of international trade. Ricardo's theory, which is still accepted by most modern economists, stresses the principle of comparative advantage. Following this principle, a country can still gain from trading certain goods even though its trading partners can produce those goods more cheaply. The comparative advantage comes if each trading partner has a product that will bring a better price in another country than it will at home. If each country specializes in producing the goods in which it has a comparative advantage, more goods are produced, and the wealth of both the buying and the selling nations increases.

Besides this fundamental advantage, further economic benefits result when countries trade with one another. International trade leads to more efficient and increased world production, thus allowing countries (and individuals) to consume a larger and more diverse bundle of goods. A nation possessing limited natural resources is able to produce and consume more than it otherwise could. As noted earlier, the establishment of international trade expands the number of potential markets in which a country can sell its goods. The increased international demand for goods translates into greater production and more extensive use of raw materials and labor, which in turn leads to growth in domestic employment. Competition from international trade can also force domestic firms to become more efficient through modernization and innovation.

Within each economy, the importance of foreign trade varies. Some nations export only to expand their domestic market or to aid economically depressed sectors within the home economy. Other nations depend on trade for a large part of their national income and to supply goods for domestic consumption. In recent years foreign trade has also been viewed as a means to promote growth within a nation's economy. Developing countries and international organizations have increasingly emphasized such trade.

IV

GOVERNMENT RESTRICTIONS

Because foreign trade is such an integral part of a nation's economy, governmental restrictions are sometimes necessary to protect what are regarded as national interests. Government action may occur in response to the trade policies of other countries, or it may be resorted to in order to protect specific industries. Since the beginnings of international trade, nations have striven to achieve and maintain a favorable balance of trade—that is, to export more than they import.

In a money economy, goods are not merely bartered for other goods. Instead, products are bought and sold in the international market with national currencies. In an effort to improve its balance of international payments (that is, to increase reserves of its own currency and reduce the amount held by foreigners), a country may attempt to limit imports. Such a policy aims to control the amount of currency that leaves the country.

A

Import Quotas

One method of limiting imports is simply to close the ports of entry into a country. More commonly, maximum allowable import quantities may be set for specific products. Such quantity restrictions are known as quotas. These may also be used to limit the amount of foreign or domestic currency that is permitted to cross national borders. Quotas are imposed as the quickest means to stop or even reverse a negative trend in a country's balance of payments. They are also used as the most effective means of protecting domestic industry from foreign competition.

B

Tariffs

Another common way of restricting imports is by imposing tariffs, or taxes on imported goods. A tariff, paid by the buyer of the imported product, makes the price higher for that item in the country that imported it. The higher price reduces consumer demand and thus effectively restricts the import. The taxes collected on the imported goods also increase revenues for the nation's government. Furthermore, tariffs serve as a subsidy to domestic producers of the items taxed because the higher price that results from a tariff encourages the competing domestic industry to expand production. See also Free Trade; Tariffs, United States.

C

Nontariff Barriers to Trade

In recent years the use of nontariff barriers to trade has increased. Although these barriers are not necessarily administered by a government with the intention of regulating trade, they nevertheless have that result. Such nontariff barriers include government health and safety regulations, business codes of conduct, and domestic tax policies. Direct government support of various domestic industries is also viewed as a nontariff barrier to trade, because such support puts the aided industries at an unfair advantage among trading nations.

V

20TH-CENTURY TRENDS

In the first half of the 20th century, equal tariffs for similar goods was not the policy of all nations. Countries levied differential tariffs (charging lower tariffs to favored nations) and established other restrictive trading practices as weapons to fight unfriendly nations. Trade policy became the source of many international economic disputes, and trade was severely affected during times of war.

A

Trade Negotiations

Attempts were first made in the 1930s to coordinate international trade policy. At first countries negotiated bilateral treaties. Later, following World War II, international organizations were established to promote trade by, for example, liberalizing tariff and nontariff trade barriers. The General Agreement on Tariffs and Trade, or GATT, signed by 23 non-Communist nations in 1947, was the first such agreement designed to remove or loosen barriers to free trade. GATT members held a number of specially organized rounds of negotiations that significantly reduced tariffs and other restrictions on world trade. After the round of negotiations that ended in 1994, the member nations of GATT signed an agreement that provided for establishment of the World Trade Organization (WTO). The WTO began operation in January 1995 and coexisted with GATT until December 1995, after which GATT ceased to exist. All of the 128 contracting parties to the 1994 GATT agreement eventually transferred membership to the WTO. See also Commercial Treaties.

B

Trading Communities and Customs Unions

The largest trading community in the world began in Europe in 1948 with the founding of the customs union known as Benelux—Belgium, the Netherlands, and Luxembourg. In 1951 France, West Germany, and the Benelux countries formed the European Coal and Steel Community (ECSC). These nations established the European Economic Community (EEC), often called the Common Market, in 1957. The ECSC, EEC, and other entities merged in 1967 to form the European Community (EC), which was succeeded in 1993 by the European Union.

Several other trading communities have been established to promote trade among countries that have common economic and political interests or are located in a particular region. Within these trade groups, preferential tariffs are administered that favor member countries over nonmembers. Non-Communist countries encouraged trade-promoting programs to stimulate the redevelopment of economies ruined during World War II. The North American Free Trade Agreement (NAFTA), ratified by Mexico, the United States, and Canada in 1993, was designed to bring about a free market in everything produced and consumed in the three countries.

In 1995 the South American free-trade group known as Mercosur began working with the EU in an attempt to forge a free-trade agreement between the two groups. Bolivia and Chile became associate members of Mercosur in 1996, with Peru (2003) and Venezuela (2004) achieving the same status in ensuing years. In 2004 Mercosur joined with the Andean Community to form the South American Community of Nations, bringing wider economic integration to the continent. The alliance became the world’s third largest trading bloc, behind the EU and the economies of the countries belonging to NAFTA.

In 2005 the Central American Free Trade Agreement (CAFTA) was approved. It lowered trade barriers between Costa Rica, the Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua, and the United States.

VI

U.S. TRADE

In 2004, U.S. exports totaled about $818 billion, and U.S. imports, $1.53 trillion. Manufactured goods constituted 81.7 percent of all U.S. exports in 2004, and food products accounted for another 7.3 percent. Major exports also included chemicals, grains and grain products, soybeans, and coal. Of imports to the United States in 2004, 74.4 percent were manufactured goods and 14.2 percent were fuels. Among essential materials imported were rubber, tin, graphite, sugar, coffee, tea, and energy resources. In the 1960s, the United States experienced an erosion of its dominant position in world trade, and in most of the years after 1970, it reported a negative trade balance (more imports than exports). The U.S. share of world manufactured exports declined from 25.3 percent in 1960 to 10.8 percent in 2003. The American trade deficit with Japan was perceived to be a growing problem.

VII

WORLD TRADE

In 2000 world trade (total exports) was approximately $6.5 trillion, more than triple the figure for 1980. Driven by inflation and higher prices for commodities such as oil, the value of world trade in U.S. dollars increased nearly 20 times from 1970 to 2000.

In the 21st century, trade has increased, becoming a more dominant segment of the world's economy. It is expected that the trend toward increasing interdependence among national economies will continue into the future.