International Trade

International Trade Definition

Consumers and countries trade because they believe that they would benefit from the trade. They believe the products they purchase are more valuable than the price they pay or the products they give up. Furthermore, the availability of different products is also increased thanks to international trade.

In a global world, trading between countries or consumers provides access to a wider spectrum of products and services.

Coffee and most smartphones are imports, WikipediaCommons

International Trade Economics

In an international and global world, international trade allows countries to specialize in some products and services and trade them for other products and services that are not possible or more costly to produce.

Thus, specialization is the main reason for international trade. When countries specialize, they produce the products and services they are good at producing. This can be in several ways: the country may have higher amounts of the required resources, has developed technology in the production of that product, or might have lower wages which decrease the production costs for these products.

If we want to understand what a country specializes in, we should look at the exports of the country.

Similarly, if we want to understand what the country buys from other countries, we should look at the imports.

International trade has significant importance in all economies. Even though you have a high GDP and well-developed technology, every product has an opportunity cost. In other words, even though the product could be efficiently produced in your country, it would still make sense to get involved in international trade and buy this product from another country, because you might use the production effort and cost to produce another product that you can produce even more efficiently or that has a higher value.

Because of that, developed and developing countries are involved in international trade. The trading volume among countries with significant differences in culture, geography, politics, or religion is very high. This indicates that the trade is beneficial for all of them, despite their other differences.

International Trade Theory

The international trade theory is based on a very simple logic: trade is beneficial when countries focus on the products they can produce best.

What do we mean when we say that everybody specializes in "what they do best"? We mean comparative advantage, not absolute advantage. What if one country seems to be better at everything? Well, then we say that country has an absolute advantage.

A country has an absolute advantage when producing more output with the same resources. Notice that a country that can produce the same amount of output with fewer resources also has an absolute advantage. Suppose a country can produce more output with the same resources. In that case, it is equivalent to say that for each unit of output, the country can produce it faster, with fewer people, or with fewer resources overall.

When we say that everyone should specialize in "what they do best," we do not mean they should specialize in what they have an absolute advantage in. They could have an absolute advantage in everything! When comparing two countries with two goods, each one has a comparative advantage ove one of the two goods.

For there to be gains from specialization and trade, each country should specialize in the good for which it has the lowest opportunity cost. The total amount of output that can be produced is increased in this way.

International Trade Examples

Pursuing complete economic self-sufficiency is probably unrealistic in a modern and global world. Geographically, few countries possess enough natural resources to make all components of contemporary products.

Think about modern automobiles which require many metal alloys, rubber, plastic, glass, and various fabrics. Few nations have the resources to mass-produce all of these and make them cost-effectively. Therefore, it is easier to trade for these goods rather than rely on self-sufficiency.

Consider China and the United States as an example. China's comparative advantage over the United States comes in the form of cheap labor, which the United States cannot match. Chinese employees create basic consumer items at a lower opportunity cost than their counterparts in the United States. The reason for that is that China has a larger amount of unskilled labor compared to the U.S. That's why using this labor in the production of basic customer items doesn't come with much opportunity cost for China.

On the other hand, a specialized, high-skilled workforce is where the United States has a comparative advantage. American employees generate sophisticated items or investment possibilities at lower opportunity costs than their counterparts in China. Specializing and trading in this manner are beneficial to both parties: the U.S. and China.

US and China Trade Discussions, Wikipedia Commons

International Trade Barriers

Tariffs and quotas are the main trade barriers in international trade.

There are generally two types of tariffs: protective tariffs and revenue tariffs. Protective tariffs aim to protect the less-efficient domestic industries and prevent these industries from being undersold by foreign industries. On the other hand, revenue tariffs aim to generate revenue for the government without prohibiting imports.

In addition to tariffs and quotas, there are other trade barriers as well. If the imported goods are foods, they are probably subject to some health inspections. Furthermore, some countries might require a license to import, and it may take time to report these licenses, which makes the process slow and becomes a barrier.

Nationalism, culture, or even geography might also be trade barriers: some countries prefer to trade within a nation or with neighboring countries due to cultural reasons (because they share more common values) or financial reasons (the trading costs generally increase as the distance among countries rises).