Overview: International Trade

What It Means

International trade is any legal exchange of goods and services between countries. When a business in one country exports goods or services to consumers in another country, it is called international trade. International trade also takes place when consumers in one country import goods and services from a foreign producer.

An import is a product that is purchased from international sources for domestic consumers, and an export is a product that is made by domestic producers and is sold to international buyers. In general, the products a country exports are those it has efficiency in producing. Japan, for example, exports electronics and automobiles because it manufactures those goods more efficiently than many other countries do. A country might also export its natural resources as goods. For example, Saudi Arabia and other Middle Eastern countries with an abundance of domestic oil fields export oil to many countries around the world that do not have rich oil reserves.

International trade is important because it allows national markets to provide a diversity of goods and services to their consumers that they would be unable to provide if they were limited to the production of goods and services within their borders. The result of international trade is that almost any type of good is available on the international market, from resources such as oil, water, and steel to necessities such as food, clothing, and building materials to luxury goods such as diamonds, designer clothing, and limousines. Many services are traded internationally, such as legal, accounting, advertising, banking, and tourism services. Another important result of international trade is that the more manufacturers that participate in an industry, the greater the competition between manufacturers becomes. Greater competition results in more competitive prices, which means that consumers have access to a number of inexpensive products.

When Did It Begin?

The beginnings of international trade date back to the ancient world when people first began traveling long distances to exchange goods. The Silk Road, a 5,000-mile long system of interconnected routes, was used by traders and travelers from 200 bc to ad 900 and linked China to Greece and other Mediterranean countries. Initially established to support the transportation of Chinese silks to the west, the Silk Road was also used to export other Chinese goods, such as porcelain, spices, gunpowder, and paper. Over time, the Chinese used the Silk Road to import such goods as cosmetics, silver, and perfume produced by European, Central Asian, Arabian, and African suppliers.

In the mid-sixteenth century a philosophy supporting international trade emerged in England. Known as mercantilism, the theory asserted that gold and silver (the currency of the time) were the basis of a nation’s wealth and crucial to healthy and active commercial activity. By exporting goods a country could earn gold and silver, but when it imported goods, it paid for these with gold and silver. According to mercantilism, it is in a country’s best interest to export more than it imports, or to maintain what is called a “trade surplus.” Since national wealth and prestige hinged on accumulations of gold and silver, those countries with the highest value of exports were the most powerful.

Scottish philosopher and economist Adam Smith (1723–90) criticized mercantilism in his book An Inquiry into the Nature and Causes of the Wealth of Nations. Smith asserted that each country differs from others in its ability to produce goods efficiently. For example, the English had the advantage of efficiently manufacturing textiles, while the French had the advantage in producing wine. Smith argued that countries should not attempt to produce goods domestically that can be purchased for a cheaper price internationally. A country benefits, said Smith, by focusing on the goods that it can produce most advantageously and by trading them on the international market. Smith’s influential arguments helped shape the production and trade of goods and services in developed economies around the world.

More Detailed Information

International trade has many economic benefits. If a country does not have the assets or natural resources to produce a good efficiently, it can trade with another country to acquire that item. For example, Sweden benefits from trading products it can produce efficiently and at low cost, such as iron ore, for products it cannot produce at home, such as grapefruit. When a country is able to produce a particular good efficiently and focuses on the production of that good in order to export it to other countries, it is known as specialization.

When a country is more efficient at producing a particular good than any other country, it is said to have an absolute advantage. The production of any good (the output) requires such resources as labor, materials, money, and land (the input). Countries determine whether or not they have an absolute advantage in the production of a certain good by calculating the units of resources (the sum of inputs) they use to produce that particular good. A country has an absolute advantage in the production of a good when it uses the lowest number of units of resource to produce that good. When Country A specializes in the production of a good that it has an absolute advantage in producing and then trades with Country B for the exchange of another product for which Country B has the absolute advantage, the production of both goods is increased.

At times it is beneficial for two countries to trade one product for another even if a country has the absolute advantage in producing both products. For example, France produces a wide variety of cheese and has an abundant supply of dairy milk. Japan produces a wide variety of televisions and has an extensive electronics manufacturing base. If France wanted to produce televisions, it would have to take substantial resources out of industries it currently has. Likewise, if Japan wanted to manufacture cheese, it would need to take resources out industries, such as electronics, and develop a production process for making cheese. Thus, for France to start making televisions and for Japan to begin making cheese, both would have to give up something. In economics this trade-off is called an opportunity cost. But even if we suppose that Japan could make both televisions and cheese at a lower cost than France could, it might still make sense for Japan to continue its current production level of televisions and to buy cheese from France. This is because what matters to Japan is how it can most profitably use its limited resources, not whether it can make cheese at a lower cost than France. If Japan makes more money manufacturing televisions than it would in producing cheese (thus making more efficient use of its limited resources), it would be better off making televisions and using some of its profits from television production to buy French cheese. Thus, even though in this example Japan maintains an absolute advantage over France in cheese production (as it can produce cheese at less cost than France), France has a comparative advantage over Japan in making cheese, as cheese production benefits France’s economy more than it does Japan’s.

International trade also allows countries to participate in a global, or worldwide, economy. As more countries participate in the international market, more international investment takes place. When a business invests its money or other resources in business activities outside of its home country, it is known as foreign direct investment (FDI). A business may recognize that labor is cheaper in another country and decide to build a factory there to produce its goods. For example, if a U.S. boat manufacturer builds a manufacturing plant in Thailand, the U.S. company is making a foreign direct investment. Foreign direct investment may also mean that a firm manages a foreign company or invests in a project with a foreign company. If the U.S.-based boat manufacturer buys a company in Thailand, this is also an example of foreign direct investment. With increased foreign investment, nationally based economies can grow more quickly and can more easily become competitors in the global economic market. FDI can also improve employment rates and the growth rate of the gross domestic product (GDP), a measurement of the market value of all goods and services produced in a country. For most countries, money made through international trade constitutes a significant portion of the country’s GDP.

Countries trading on the international market typically try to keep the value of their imports and the value of their exports in equilibrium, or balance. Balance of trade is the term used to describe the difference between the value of the goods and services a country imports and the value of the goods and services it exports. When the value of exported goods and services is greater than the value of imported goods and services in a given period, it is called a trade surplus because the balance of trade is positive. When the value of imported goods and services is greater than the value of exported goods and services, it is called a trade deficient because the balance of trade is negative.

Recent Trends

Since the mid-twentieth century, national economic markets have become so integrated with one other that they have begun to function together as one large global market rather than separate economies. Separate economic systems, at one time isolated by geography and poor transportation and communication, have become increasingly less isolated. Barriers to international trade, such as tariffs (taxes) on imports, have been gradually removed. Differences in time zones, languages, government regulations, cultures, and business systems no longer hinder international trade as they once did.

The Internet is one of the major forces causing international trading practices to evolve rapidly. The Internet has greatly eased businesses’ ability to import products across borders and make a profit selling them locally. Internet sales of all types of products have driven up the volume and diversity of international trade.

One of the most common ways for countries to encourage open trade is to open what are called free-trade zones. In these zones, such barriers as tariffs and import quotas (government-imposed limits on the quantity of the goods or services that may be imported over a specified period of time) are officially removed and bureaucratic restrictions lifted so that business can practice free trade. Examples of free-trade zones are the Jamaican Free Zone and the Jebel Ali Free Zone, located in Dubai, United Arab Emirates.