International Trade

Exports and Imports An export is any good or service provided by residents of a country which, when sold, causes money to come into the country. An import is any good or service availed of by residents of a country that causes money to leave the country.

Visible Exports and Imports A visible export is any physical product supplied by residents of a country which, when sold, causes money to enter the country. Examples of Ireland’s visible exports are: Pharmaceutical products manufactured in Ireland and sold abroad. Computer chips manufactured in Ireland and sold abroad. A visible import is any physical product purchased by residents of a country that causes money to leave the country. Examples of Ireland’s visible imports are: The purchase of cars from abroad. The purchase of timber from abroad.

Invisible Exports An invisible export is any service provided by residents of a country which causes money to come into the country. Examples of Ireland’s invisible exports are: Residents of other countries holidaying in Ireland. Residents of another country using the services of an Irish firm of architects.

Invisible Imports An invisible import is any service availed of by residents of a country which causes money to leave the country. Examples of Ireland’s invisible imports are: The use of a foreign owned transport company to deliver Irish exports. Residents of Ireland holidaying abroad.

The Balance of Payments The Balance of Payments is a record of the economic transactions of a country with the rest of the world. It is made up of three sections or accounts: The Current Account The Capital Account The Financial Account.

The Current Account This is composed of: The difference between the value of visible exports and visible imports, known as the Balance of Trade or The Balance on Visible Trade. The difference between the value of invisible exports and invisible imports, known as The Balance on Invisible Trade. Net Factor Income from abroad, which covers items such as interest and dividends and repatriation of profits as explained in the chapter on National Income. Net Current Transfers from abroad, such as subsidies and other current transfers receivable from, and taxes payable to, the European Union.

The Capital Account and the Financial Account The Capital Account covers amounts receivable under the EU Regional Development Fund and the Cohesion Fund and the balance of all other transfers, in and out of the country, intended for capital purposes. The Financial Account is concerned with transactions in foreign financial assets and liabilities under four headings: direct investment portfolio investment other investment reserve assets.

Balance of Trade When the value of visible exports > the value of visible imports then there is a favourable balance of trade or a surplus on the balance of trade. When the value of visible imports > the value of visible exports then there is an unfavourable balance of trade a deficit on the balance of trade

Example of Balance of Payments 31/3/07 Current Account €m Balance on Visible Trade 5,336 Balance on Invisible Trade 880 Net Factor Income 6,999 Current Transfers 728 Capital Account Balance 30 Balance on Current Account 3,241 Financial Account €m Direct Investment 3,654 Portfolio Investment 6,331 Other Investments 2,220 Reserve Assets 47 Balance 503 + Net Errors and Omissions 3,744 Balance on Financial Account 3,241

The Terms of Trade This is the relationship between the average price received for a unit of exports and the average price paid for a unit of imports. It reflects the number of units of imports that can be purchased with a unit of exports. The formula for measuring it is: The Index of Export Prices The Index of Import Prices  100

Terms of Trade If the result of the formula is: > 100 we are said to have favourable terms of trade. That is, the average price of a unit of exports is greater than the average price of a unit of imports. < 100 we are said to have unfavourable terms of trade. That is the average price of a unit of imports is greater than the average price of a unit of exports.

Movement in Terms of Trade A favourable movement in the terms of trade occurs when the index increases in value. For example, if the index changes from 89 to 94 this is a favourable movement in the terms of trade . An unfavourable movement in the terms of trade occurs when the index decreases in value . For example, if the index changes from 110 to 108 this is an unfavourable movement in the terms of trade .

Reasons Why Countries Participate in International Trade Countries import to obtain consumer goods that cannot be made, or cannot be made at a reasonable price, in their own country. Countries import to obtain raw materials/capital goods that are not available in their own country. Continued .....

Reasons Why Countries Participate in International Trade Countries export in order to earn foreign currency to pay for their imports. Countries export to enable them to increase their production levels to obtain the benefits of the economies of scale. This is particularly important for countries that have a small population. This increases the total wealth available and lowers the cost of the goods to consumers in our own country. Countries export in order to sell off their surplus production. This is tied in with the previous reason as it allows countries to increase production above the level required for domestic consumption. Countries export in order to create employment in their own country which would not otherwise be created. Continued .....

Reasons Why Countries Participate In International Trade. Countries export in order to increase their national income and thus their standard of living. The more goods we sell the more income we earn thus we can increase our standard of living Countries export in order to create economic growth or to stimulate economic recovery. If residents can’t afford to buy goods produced in their own country in their own country then these goods should be sold abroad. This brings in money which the residents can now start to spend in their own country thus boosting the economy.

The Law of Absolute Advantage This law states that countries will benefit from trade so long as each of the countries trading has an absolute advantage in the production of one of the goods being traded. A country has an absolute advantage when it uses less of its resources to produce one unit of a product than the other country uses .

The Law of Absolute Advantage Assume: There are two countries, “A” and “B”. Each produces two products, “X” and “Y”. Each uses a given amount of resources on the production of each product. The figures before any specialisation are as follows. “A” has an absolute advantage in “Y” and “B” has an absolute advantage in “X”. Product X Product Y Country A 300 100 Country B 600 50 Total 900 150

The Law of Absolute Advantage They now specialise in the production of these products and allowing for constant returns to scale (if you double the inputs, output will double), the figures will now read: It is obvious that the total production of both products has increased. Therefore there is more wealth available to be shared by each country. Product X Product Y Country A 200 Country B 1,200 Total

The Law of Absolute Advantage The countries now trade with each other and the figures after trade are: After trade Product X Product Y Country A 400 120 Country B 800 80 Total 1,200 200 Each country now has more units of both goods than they had before any specialisation, so both have gained from the trade. Before specialisation Product X Product Y Country A 300 100 Country B 600 50 Total 900 150 This can be seen clearly when you contrast the figures before any specialisation with the figures after trade.

Law of Comparative / Relative Advantage This law states that a country should specialise in the production of those goods and services in which it is relatively most efficient and obtain its other requirements through trade, assuming there is free trade between the countries.

Law of Comparative / Relative Advantage Make the same assumptions as for the Law of Absolute Advantage. The figures before specialisation are as shown below. Product “X” Product “Y” Country “A” 1,000 2,100 Country “B” 250 700 Total 1,250 2,800 You can see that country “A” has an absolute advantage in the production of both products. However it is relatively more efficient in the production of “X” (i.e. 4:1 compared to 3:1). Therefore “A” should produce “X” and leave the production of “Y” to “B”.

Law of Comparative / Relative Advantage The figures after specialisation are shown below . Product “X” Product “Y” Country “A” 2,000 Country “B” 1,400 Total The total production of Product “X” has increased from 1,250 to 2,000 – an increase of 60%. However, the total production of “Y” has decreased from 2,800 to 1,400 – a decrease of 50%. This gives an overall increase in wealth of 10%. However, we still have to prove that both countries can gain from trading.

Law of Comparative / Relative Advantage Assume that trade takes place and the figures after trade are as follows: Product “X” Product “Y” Country “A” 1,600 1,050 Country “B” 400 350 Total 2,000 1,400 Both countries now have more of Product “X” than they had before any specialisation took place, but they also have less of Product “Y”.

Proof of Gain Country “A” Before specialisation “A” had 1,000 of “X” “A” now has 1,600, a gain of 600/1,000 = + 60% Before specialisation “A” had 2,100 of “Y” “A” now has 1,050, a loss of 1,050/2,100= – 50% This gives “A” an overall gain of + 10% Country “B” Before specialisation “B” had 250 of “X” “B” now has 400, a gain of 150/250 = + 60% Before specialisation “ B” had 700 of “Y” “B” now has 350, a loss of 350/700 = – 50% This also gives “B” an overall gain of + 10%

Assumptions Governing Laws of Absolute and Comparative Advantage There is free trade. Transport costs are negligible. The factors of production are mobile. The benefits of the trade are distributed throughout the economies. There are constant returns to scale.

Summary of Arguments Against Free Trade To protect domestic employment. Infant industry argument. To protect the balance of payments. To protect against competition from “low wage” countries. To maintain government revenue. For strategic purposes. To prevent “dumping”. As a retaliatory measure for not being allowed access to another country’s market. Exporter does not comply with environmental/labour laws.

Restrictions on Free Trade Customs duties / tariffs These are taxes levied on imported goods to make them more expensive than domestically produced goods. When price goes up demand usually goes down; therefore, these should reduce the demand for imported goods. Embargoes These are a complete ban on the importation of certain goods. Quotas This is setting a limit on the number of units of a product which can be imported. Continued …..

Restrictions on Free Trade Exchange Control Regulations This is a system where the central bank does not make foreign currency available to importers to pay for their goods. Therefore, they are unable to place orders for imports. Administrative Regulations Here the government imposes so many regulations re specifications, certificates, form filling etc. that it discourages importers from importing. Subsidies To Domestic Producers The government pays a subsidy (a direct payment per unit produced), to domestic producers of goods so that they can sell their products on the home market at a cheaper price than the imported goods.

Factors Affecting International Competitiveness of Irish Industry Rate of inflation in Ireland versus rate of inflation in competitors’ countries. Value of the Euro versus value of other currencies. Transport Costs. Labour costs. Social Partnership Agreements / National Wage Agreements. Poor infrastructure. Government policies.