5. The global economy

5.1. International trade

DISCOVERING CONNECTIONS

Consider the clothes and shoes you are wearing, and those you wore last weekend. Where were they made? Try to recall the meals you’ve eaten in the last 24 hours. How much of the food came from abroad? If you have them, where do your car, television, stereo, camera, watch and so on come from? Where was the last DVD or CD you bought manufactured?

Can you even imagine living in a country that did not import anything, where only locally produced food and textiles and products were available?

READING

Text 1

As you read the text, focus on the difference between absolute and comparative advantages.

International Trade

International trade is exchange of capital, goods, and services across international borders or territories. Trade in goods is known as visible exports and visible imports. Trade in services such as banking, insurance, and tourism is known as invisible exports or invisible imports.

While international trade has been present throughout much of history, its economic, social, and political importance has been on the rise in recent centuries. Industrialization, advanced transportation, globalization, multinational corporations, and outsourcing are all having a major impact on the international trade system.

International trade is a form of specialization. Sri Lanka, for example, specializes in tea because it has an appropriate climate and soil, and skilled growers and packers.

The principle of comparative advantage is a central concept in international trade. Economic theory distinguishes between absolute advantage and comparative advantage.

A country has an absolute advantage in the production of a product when it is (a) is the only country that makes the product, or (b) can make the product at a lower cost than another country.

The theory of comparative advantage embraces two related concepts: (a) a country with absolute advantages in a number of different products should concentrate on the products which bring the greatest advantage, and (b) a country with no absolute advantages should concentrate on the products which bring the least disadvantage.

The majority of economists believe that international trade should be based on comparative advantage and free trade. Free trade is a system which allows certain countries to buy and sell goods from each other without any financial restrictions.

The effects of free trade can be determined by comparing the domestic price without trade to the world price. A low domestic price indicates that the country has a comparative advantage in producing the good and that the country will become an exporter. A high domestic price indicates that the rest of the world has a comparative advantage in producing the good and that the country will become an importer.

When a country allows trade and becomes an exporter of a good, producers of the good are better off, and consumers of the good are worse off. When a country allows trade and becomes an importer of a good, consumers are better off, and producers are worse off. In both cases, the gains from trade exceed the losses. The other economic benefits of trade are:

Increased variety of goods: Goods produced in different countries are not exactly the same. Free trade gives consumers in all countries greater variety from which to choose.

Lower costs through economies of scale: Some goods can be produced at low cost only if they are produced in large quantities – a phenomenon called economies of scale. A firm in a small country cannot take full advantage of economies of scale if it can sell only in a small domestic market. Free trade gives firms access to larger world markets and allows them to realize economies of scale more fully.

Increased competition: A company shielded from foreign competitors is more likely to have market power, which in turn gives it ability to raise prices above competitive levels. This is the type of market failure. Opening up trade fosters competition and gives the invisible hand a better chance to work its magic.

Enhanced flow of ideas: The transfer of technological advances around the world is often thought to be linked to international trade in the goods that embody those advances.

International trade is a major source of economic revenue for any nation. In most countries, it represents a significant share of GDP. Without international trade, nations would be limited to the goods and services produced within their own borders.