International trade

Ancient silk road trade routes across Eurasia.

International trade is exchange of capital, goods, and services across international borders or territories.^[1]. In most countries, it represents a significant share of gross domestic product (GDP). While international trade has been present throughout much of history (see Silk Road, Amber Road), 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. Increasing international trade is crucial to the continuance of globalization. Without international trade, nations would be limited to the goods and services produced within their own borders.

International trade is in principle not different from domestic trade as the motivation and the behavior of parties involved in a trade do not change fundamentally regardless of whether trade is across a border or not. The main difference is that international trade is typically more costly than domestic trade. The reason is that a border typically imposes additional costs such as tariffs, time costs due to border delays and costs associated with country differences such as language, the legal system or culture.

Another difference between domestic and international trade is that factors of production such as capital and labour are typically more mobile within a country than across countries. Thus international trade is mostly restricted to trade in goods and services, and only to a lesser extent to trade in capital, labor or other factors of production. Then trade in goods and services can serve as a substitute for trade in factors of production. Instead of importing a factor of production, a country can import goods that make intensive use of the factor of production and are thus embodying the respective factor. An example is the import of labor-intensive goods by the United States from China. Instead of importing Chinese labor the United States is importing goods from China that were produced with Chinese labor.

International trade is also a branch of economics, which, together with international finance, forms the larger branch of international economics.

International trade uses a variety of currencies, the most important of which are held as foreign reserves by governments and central banks. Here the percentage of global cummulative reserves held for each currency between 1995 and 2005 are shown: the US dollar is the most sought-after currency, with the Euro in strong demand as well.

Models

Several different models have been proposed to predict patterns of trade and to analyze the effects of trade policies such as tariffs.

Ricardian model

The Panama Canal is important for international sea trade between the Atlantic Ocean and the Pacific Ocean.

The Ricardian model focuses on comparative advantage and is perhaps the most important concept in international trade theory. In a Ricardian model, countries specialize in producing what they produce best. Unlike other models, the Ricardian framework predicts that countries will fully specialize instead of producing a broad array of goods.

Also, the Ricardian model does not directly consider factor endowments, such as the relative amounts of labor and capital within a country. The main merit of Ricardian model is that it assumes technology differences between countries. Technology gap is easily included in the Ricardian and Ricardo-Sraffa model (See the Ricardian theory (modern deveopment)).

The Ricardian model makes the following assumptions:

1. Labor is the only primary input to production (labor is considered to be the ultimate source of value).
2. Constant Marginal Product of Labor (MPL) (Labor productivity is constant, constant returns to scale, and simple technology.)
3. Limited amount of labor in the economy
4. Labor is perfectly mobile among sectors but not internationally.
5. Perfect competition (price-takers).

The Ricardian model measures in the short-run, therefore technology differs internationally. This supports the fact that countries follow their comparative advantage and allows for specialization.

For the modern development of Ricardian model, see the subsection below: Ricardian theory of international trade.

Heckscher-Ohlin model

In the early 1900s an international trade theory called factor proportions theory emerged by two Swedish economists, Eli Heckscher and Bertil Ohlin. This theory is also called the Heckscher-Ohlin theory. The Heckscher-Ohlin theory stresses that countries should produce and export goods that require resources (factors) that are abundant and import goods that require resources in short supply. This theory differs from the theories of comparative advantage and absolute advantage since these theory focuses on the productivity of the production process for a particular good. On the contrary, the Heckscher-Ohlin theory states that a country should specialize production and export using the factors that are most abundant, and thus the cheapest. Not to produce, as earlier theories stated, the goods it produces most efficiently.

The Heckscher-Ohlin model was produced as an alternative to the Ricardian model of basic comparative advantage. Despite its greater complexity it did not prove much more accurate in its predictions. However from a theoretical point of view it did provide an elegant solution by incorporating the neoclassical price mechanism into international trade theory.

The theory argues that the pattern of international trade is determined by differences in factor endowments. It predicts that countries will export those goods that make intensive use of locally abundant factors and will import goods that make intensive use of factors that are locally scarce. Empirical problems with the H-O model, known as the Leontief paradox, were exposed in empirical tests by Wassily Leontief who found that the United States tended to export labor intensive goods despite having a capital abundance.

The H-O model makes the following core assumptions:

1. Labor and capital flow freely between sectors
2. The production of shoes is labor intensive and the production of computers is capital intensive
3. The amount of labor and capital in two countries differ (difference in endowments)
4. Free trade
5. Technology is the same across countries (long-term)
6. Tastes are the same.

The problem with the H-O theory is that it excludes the trade of capital goods (including materials and fuels). In the H-O theory, labor and capital are fixed entities endowed to each country. In a modern economy, capital goods are traded internationally. Gains from trade of intermediate goods are considerable, as it was emphasized by Samuelson (2001).

Reality and Applicability of the Heckscher-Ohlin Model

The Heckscher-Ohlin theory is preferred to the Ricardo theory by many economists, because it makes fewer simplifying assumptions. In 1953, Wassily Leontief published a study, where he tested the validity of the Heckscher-Ohlin theory^[2]. The study showed that the U.S was more abundant in capital compared to other countries, therefore the U.S would export capital- intensive goods and import labour-intensive goods. Leontief found out that the U.S's export was less capital intensive than import.

After the appearance of Leontief's paradox, many researchers tried to save the Heckscher-Ohlin theory, either by new methods of measurement, or either by new interpretations. Leamer^[3] emphasized that Leontief did not interpret HO theory properly and claimed that with a right interpretation paradox did not occur. Brecher and Choudri^[4] found that, if Leamer was right, the American workers consumption per head should be lower than the workers world average consumption.

Many other trials followed but most of them failed.^[5][6] Many of famous textbook writers, including Krugman and Obstfeld and Bowen, Hollander and Viane, are negative about the validity of H-O model.^[7][8]. After examining the long history of empirical research, Bowen, Hollander and Viane concluded: "Recent tests of the factor abundance theory [H-O theory and its developed form into many-commodity and many-factor case] that directly examine the H-O-V equations also indicate the rejection of the theory."^[8]:321

Heckscher-Ohlin theory is not well adapted to the analyze South-North trade problems. The assumptions of HO are less realistic with respect to N-S than N-N (or S-S) trade. Income differences between North and South is the one that third world cares most. The factor price equalization [a consequence of HO theory] has not shown much sign of realization. HO model assumes identical production functions between countries. This is highly unrealistic. Technological gap between developed and developing countries is the main concern of the poor countries^[9].

Specific factors model

Current members of the World Trade Organisation.

Global Competitiveness Index (2008-2009): competitiveness is an important determinant for the well-being of states in an international trade environment.

In this model, labor mobility between industries is possible while capital is immobile between industries in the short-run. Thus, this model can be interpreted as a 'short run' version of the Heckscher-Ohlin model. The specific factors name refers to the given that in the short-run, specific factors of production such as physical capital are not easily transferable between industries. The theory suggests that if there is an increase in the price of a good, the owners of the factor of production specific to that good will profit in real terms.

Additionally, owners of opposing specific factors of production (i.e. labor and capital) are likely to have opposing agendas when lobbying for controls over immigration of labor. Conversely, both owners of capital and labor profit in real terms from an increase in the capital endowment. This model is ideal for particular industries. This model is ideal for understanding income distribution but awkward for discussing the pattern of trade.

New Trade Theory

New Trade theory tries to explain several facts about trade, which the two main models above have difficulty with. These include the fact that most trade is between countries with similar factor endowment and productivity levels, and the large amount of multinational production(i.e.foreign direct investment) which exists. In one example of this framework, the economy exhibits monopolistic competition and increasing returns to scale. There are three basic theories that global marketer has to comprehend: 1. Comparative Advantage Theory 2. Trade or product trade cycle theory 3. Business orientation theory

Gravity model

The Gravity model of trade presents a more empirical analysis of trading patterns rather than the more theoretical models discussed above. The gravity model, in its basic form, predicts trade based on the distance between countries and the interaction of the countries' economic sizes. The model mimics the Newtonian law of gravity which also considers distance and physical size between two objects. The model has been proven to be empirically strong through econometric analysis. Other factors such as income level, diplomatic relationships between countries, and trade policies are also included in expanded versions of the model.

Ricardian theory of international trade (modern development)

The Ricardian theory of comparative advantage became a basic constituent of neoclassical trade theory. Any undergraduate course in trade theory includes expansions of Ricardo's example of four numbers in for form of a two commodity, two country model.

This model was expanded to many-country and many-commodity cases. Major general results were obtained by the beginning of 1960's by McKenzie^[10] and Jones^[11], including his famous formula. It is a theorem about the possible trade pattern for N-country N-commoditty cases. Let a_ij be the labor input coefficent for a country i and for the industry j (or for the production of good j). If a trade pattern i country specialises in i industry, then the product

  a11 a22 ... aNN  

is strictly smaller than any permutation products of the form

  a1σ(1) a2σ(2) ... aNσ(N)  

for any perumutation σ　except the identity permuation which transforms i onto i.

Contemporary theories

Ricardo's idea was even expanded to the case of continuum of goods by Dornbusch, Fischer, and Samuelson^[12] This formulation is employed for example by Matsuyama ^[13] and others. These theoris uses the special property which is applicable only for two coutry case.

Neo-Ricardian trade theory

Inspired by Piero Sraffa, a new strand of trade theory emerged and was named neo-Ricardian trade theory. The main contributors include Ian Steedman (1941-) and Stanley Metcalfe (1946-). They have criticized neoclassical international trade theory, namely the Heckscher-Ohlin model on the basis that the notion of capital as primary factor has no method of measuring it before the determination of profit rate (thus trapped in a logical vicious circle)^[14]. This was a second round of the Cambridge capital controversy, this time in the field of international trade.^[15]

The merit of neo-Ricardian trade theory is that input goods are explicitly included to the analytical framework. This is in accordance with Sraffa's idea that any commodity is a product made by means of commodities. The limit of their theory is that the analysis is limited to small country cases.

Traded intermediate goods

Ricardian trade theory ordinarily assumes that the labor is the unique input. This is a great deficiency as trade theory, for the intermediate goods occupy the major part of the world international trade. Yeats^[16] found that 30% of world trade in manufacturing is intermediate inputs. Bardhan and Jafee^[17] found that intermediate inputs occupy 37 to 38% in the imports to the US for years 1992 and 1997, whereas the percentage of intrafirm trade grew from 43% in 1992 to 52% in 1997.

McKenzie^[18] and Jones^[19] emphasized the necessity to expand the Ricardian theory to the cases of traded inputs. In a famous comment McKenzie (1954, p. 179) pointed that "A moment's consideration will convince one that Lancashire would be unlikely to produce cotton cloth if the cotton had to be grown in England."^[20] Paul Samuelson^[21] coined a term Sraffa bonus to name the gains from trade of inputs.

Ricardo-Sraffa trade theory

John Chipman observed in his survey that McKenzie stumbled upon the questions of intermediate products and discovered that "introduction of trade in intermediate product necessitates a fundamental alteration in classical analysis."^[22] It took may years until recently Y. Shiozawa^[23] succeded to remove this deficiency. The Ricardian trade theory was now constructed in a form to include intermediate input trade for the most general case of many countries and many goods. This new theory is called Ricardo-Sraffa trade theory.

It is emphasized that the Ricardian trade theory now provides a general theory which includes trade of intermediates such as fuel, machine tools, machinery parts and processed materials. The traded intermediate goods are then used as inputs of productions in the importing country. Capital goods are nothing other than inputs to the productions. Thus, in the Ricardo-Sraffa trade theory, capital goods moves freely from country to country. Labor is the unique factor of production that remains immobile in the country of its origin.

In a blog post of April 28, 2007, Gregory Mankiw compared Ricardian theory and Heckscher-Ohlin theory and stood by the Ricardian side^[24]. Mankiw argued that Ricardian theory is more realistic than the Heckscher-Ohlin theory as the latter assumes that capital does not move from country to country. Mankiw's argument contains a logical slip, for the traditional Ricardian trade theory does not admit any inputs. Shiozawa's result saves Mankiw from his slip^[25].

The neoclassical Heckscher-Ohlin-Samuelson theory only assumes production factors and finished goods. It contains no concept of intermediate goods. Therefore, it is the Ricardo-Sraffa trade theory that provides theoretical bases for the topics such as outsourcing, fragmentation and intra-firm trade.

Top trading nations

Rank	Country	Exports + Imports	Date of information
-	European Union (Extra-EU27)	$3,197,000,000,000	2009 [26]
1	United States	$2,439,700,000,000	2009 est.
2	People's Republic of China	$2,208,000,000,000	2009 est.
3	Germany	$2,052,000,000,000	2009 est.
4	Japan	$1,006,900,000,000	2009 est.
5	France	$989,000,000,000	2009 est.
6	United Kingdom	$824,900,000,000	2009 est.
7	Netherlands	$756,500,000,000	2009 est.
8	Italy	$727,700,000,000	2009 est.
-	Hong Kong	$672,600,000,000	2009 est.
9	South Korea	$668,500,000,000	2009 est.
10	Belgium	$611,100,000,000	2009 est.
11	Canada	$603,700,000,000	2009 est.
12	Spain	$508,900,000,000	2009 est.
13	Russia	$492,400,000,000	2009 est.
14	Mexico	$458,200,000,000	2009 est.
15	Singapore	$454,800,000,000	2009 est.
16	India	$387,300,000,000	2009 est.
17	Taiwan	$371,400,000,000	2009 est.
18	Switzerland	$367,300,000,000	2009 est.
19	Australia	$322,400,000,000	2009 est.
20	United Arab Emirates	$315,000,000,000	2009 est.

Source : Exports. Imports. The World Factbook.

Regulation of international trade

Traditionally trade was regulated through bilateral treaties between two nations. For centuries under the belief in mercantilism most nations had high tariffs and many restrictions on international trade. In the 19th century, especially in the United Kingdom, a belief in free trade became paramount. This belief became the dominant thinking among western nations since then. In the years since the Second World War, controversial multilateral treaties like the General Agreement on Tariffs and Trade (GATT) and World Trade Organization have attempted to promote free trade while creating a globally regulated trade structure. These trade agreements have often resulted in discontent and protest with claims of unfair trade that is not beneficial to developing countries.

Free trade is usually most strongly supported by the most economically powerful nations, though they often engage in selective protectionism for those industries which are strategically important such as the protective tariffs applied to agriculture by the United States and Europe. The Netherlands and the United Kingdom were both strong advocates of free trade when they were economically dominant, today the United States, the United Kingdom, Australia and Japan are its greatest proponents. However, many other countries (such as India, China and Russia) are increasingly becoming advocates of free trade as they become more economically powerful themselves. As tariff levels fall there is also an increasing willingness to negotiate non tariff measures, including foreign direct investment, procurement and trade facilitation. The latter looks at the transaction cost associated with meeting trade and customs procedures.

Traditionally agricultural interests are usually in favour of free trade while manufacturing sectors often support protectionism. This has changed somewhat in recent years, however. In fact, agricultural lobbies, particularly in the United States, Europe and Japan, are chiefly responsible for particular rules in the major international trade treaties which allow for more protectionist measures in agriculture than for most other goods and services.

During recessions there is often strong domestic pressure to increase tariffs to protect domestic industries. This occurred around the world during the Great Depression. Many economists have attempted to portray tariffs as the underlining reason behind the collapse in world trade that many believe seriously deepened the depression.

The regulation of international trade is done through the World Trade Organization at the global level, and through several other regional arrangements such as MERCOSUR in South America, the North American Free Trade Agreement (NAFTA) between the United States, Canada and Mexico, and the European Union between 27 independent states. The 2005 Buenos Aires talks on the planned establishment of the Free Trade Area of the Americas (FTAA) failed largely because of opposition from the populations of Latin American nations. Similar agreements such as the Multilateral Agreement on Investment (MAI) have also failed in recent years.

Risk in international trade

Companies doing business across international borders face many of the same risks as would normally be evident in strictly domestic transactions. For example,

• Buyer insolvency (purchaser cannot pay);
• Non-acceptance (buyer rejects goods as different from the agreed upon specifications);
• Credit risk (allowing the buyer to take possession of goods prior to payment);
• Regulatory risk (e.g., a change in rules that prevents the transaction);
• Intervention (governmental action to prevent a transaction being completed);
• Political risk (change in leadership interfering with transactions or prices); and
• War and other uncontrollable events.

In addition, international trade also faces the risk of unfavorable exchange rate movements (and, the potential benefit of favorable movements).^[27]

Gallery

Dual-currency cash machines in Jersey: as international trade increases, the need to handle multiple currencies is becoming more powerful.	A 1672 painting by Gérard de Lairesse: allegory of the freedom of trade (see also: free market). International trade is commonly associated with freedom of trade.	Globalisation: Peugeot in Jakarta, Indonesia. International trade coincides with the expansion of multinational corporations.	A camel caravan, still used today for international trade, especially in Sahara.
A modern camel caravan carrying goods across villages and international borders.	Triangle trade: Slaves being sold from Africa to The Caribbean, sugar from South America to New England, and Rum and other goods from North America back to Africa.	Some people do not see international trade favourably: here a person protests against the WTO in Jakarta.

See also

Lists:

• List of countries by current account balance
• List of countries by imports
• List of countries by exports
• List of international trade topics
• List of economists

Footnotes

References

• Jones, Ronald W. (1961). "Compartive Advantage and the Theory of Tariffs". The Review of Economic Studies 28 (3): 161–175. 
• McKenzie, Lionel W. (1954). "Specialization and Efficiency in World Production". The Review of Economic Studies 21 (3): 165–180. 
• Samuelson, Paul (2001). "A Ricardo-Sraffa Paradigm Comparing the Gains from Trade in Inputs and Finished Goods". Journal of Economic Literature 39 (4): 1204–1214. 

External links

Data

Official statistics

Data on the value of exports and imports and their quantities often broken down by detailed lists of products are available in statistical collections on international trade published by the statistical services of intergovernmental and supranational organisations and national statistical institutes:

• United Nations Commodity Trade Database
• WTO Statistics Portal
• Statistical Portal: OECD
• European Union International Trade in Goods Data
• European Union International Trade in Services Data (sub-collection of the Balance of payment statistics)
• European Union Exports and Imports (sub-collection of the National accounts statistics)
• Food and Agricultural Trade Data by FAO
• Brazilian Trade Data

The definitions and methdological concepts applied for the various statistical collections on international trade often differ in terms of definition (e.g. special trade vs. general trade) and coverage (reporting thresholds, inclusion of trade in services, estimates for smuggled goods and cross-border provision of illegal services). Metadata providing information on definitions and methods are often published along with the data.

Other data sources

• Resources for data on trade, including the gravity model
• Asia-Pacific Trade Agreements Database (APTIAD)
• Asia-Pacific Research and Training Network on Trade (ARTNeT)
• International Trade Resources

Other external links

• The Expected Benefits of Trade Liberalization for World Income and Development: Opening the "Black Box" of Global Trade Modeling by Antoine Bouët (2008)
• The McGill Faculty of Law runs a Regional Trade Agreements Database that contains the text of almost all preferential and regional trade agreements in the world. ptas.mcgill.ca
• Interactive Ricardian Model Simulator
• Consumers for World Trade Education Fund electronic trade library
• International trade, Encyclopædia Britannica
• Benefits of International Trade
• Should trade be considered a human right?
• Penn Program on Regulation's Import Safety Page
• Articles on EU international trade in Statistics explained.