International Economics: Trade, Payments, and Forex

International Trade: Core Justifications

The fundamental justification for international trade is to obtain goods and services not readily available or efficiently produced in the domestic country.

Factors Driving International Trade

• Production Costs: These depend on a country's endowment of factors of production (e.g., labor, capital, natural resources) and the technology utilized, significantly influencing prices.
• Demand: International trade is promoted by the diverse needs of a population. It is challenging for any single country to produce everything necessary to meet all its domestic demands.

Understanding Protectionism

Protectionism refers to a set of government actions aimed at restricting the entry of foreign products into a country, primarily to safeguard domestic industries from international competition.

Objectives and Tools of Protectionism

Key Objectives:

• Protection of strategic domestic industries.
• Promotion of industrialization and job creation within the country.
• Development and nurturing of emerging industries.
• Generation of government revenue through tariffs.

Common Protectionist Tools:

• Tariffs: Imposing taxes on imported goods.
• Quotas: Setting limited allocations or maximum quantities for foreign products.
• Subsidies: Providing financial support or other trade policies to promote domestic industries.
• Non-Tariff Barriers (NTBs): A broad category including regulations, standards, and administrative procedures that hinder imports.

Free Trade Principles and Benefits

Free trade embodies the idea of unrestricted competition among companies in the international arena, driven by free-market principles.

Arguments for Free Trade:

• Increased Efficiency: Leads to a more effective allocation and utilization of production factors globally.
• Enhanced Competition: Fosters greater competition among businesses, encouraging innovation and efficiency.
• Greater Variety: Provides consumers with a wider variety of goods and services.
• Economies of Scale: Facilitates the achievement of economies of scale, which are cost advantages gained by companies as they increase the volume of goods produced.

Understanding the Balance of Payments (BOP)

The Balance of Payments (BOP) is an accounting document that systematically records all economic transactions between a country and the rest of the world over a specific period, typically a year.

Structure of the Balance of Payments:

1. Current Account:

   This part of the Balance of Payments details the purchases and sales of goods and services, as well as income and transfers, between a country and other nations.

   • Goods (Trade Balance): Exports and imports of tangible goods.
   • Services: Exports and imports of intangible services (e.g., tourism, shipping, financial services).
   • Primary Income: Income earned from investments abroad (e.g., interest, dividends) and compensation of employees.
   • Secondary Income (Current Transfers): Unilateral transfers, such as foreign aid, remittances, and grants.

2. Capital Account:

   This account primarily reflects capital transfers (e.g., debt forgiveness, inheritance taxes) and the acquisition or disposal of non-produced, non-financial assets (e.g., patents, copyrights, land by embassies).

3. Financial Account:

   This section of the Balance of Payments records a country's international financial flows, including the acquisition and disposal of financial assets and liabilities.

   • Direct Investment: Long-term investments that establish a lasting interest and control (e.g., building a factory abroad, foreign companies investing domestically).
   • Portfolio Investment: Investments in financial assets such as stocks and bonds, where the investor does not gain significant control.
   • Other Investment: Loans, currency and deposits, trade credits, and other financial transactions.

Foreign Exchange Markets and Exchange Rates

When countries import goods and services, payments are typically made in currencies other than their own, necessitating the use of foreign exchange markets.

Key Concepts in Foreign Exchange:

• Currency Convertibility: The ability of a currency to be freely exchanged for another currency. Note that only certain currencies are fully convertible.
• Exchange Commission: The fee charged by financial intermediaries (e.g., banks, brokers) for facilitating currency exchange services.

Types of Exchange Rates:

1. Official (Fixed) Exchange Rate:

   The official price of a currency fixed by the monetary authorities of a customs territory. In a fixed system:

   • If the official rate is lowered: Devaluation
   • If the official rate is raised: Revaluation

2. Market (Floating) Exchange Rate:

   Refers to the price of a currency determined by the forces of supply and demand in the foreign exchange market.

   • Appreciation: When a currency's value rises relative to others, often due to increased demand or scarcity.
   • Depreciation: When a currency's value falls relative to others, often due to excess supply or reduced demand.

Factors Influencing Currency Demand:

• Trade Balance (Exports/Imports)
• Inflation Rate Differentials
• Interest Rate Differentials
• Economic and Political Stability
• Central Bank Interventions and Expectations

Monetary Systems (Exchange Rate Regimes):

1. Free Float: The exchange rate is determined purely by market forces, with minimal central bank intervention.
2. Managed Float (Dirty Float): The exchange rate is primarily market-determined, but the central bank intervenes periodically to influence its value.
3. Adjustable Peg: A mixed system where the currency is pegged to another currency but can be revalued or devalued periodically by the authorities.
4. Fixed Peg: The currency's value is permanently fixed to another currency or a basket of currencies.