Foreign trade implies trading goods and services that are destined for a country other than their country of origin. It is all about imports and exports. It exists because some nations are adept at producing certain products at a cost-effective price. Perhaps it is because they have the labor supply or abundant natural resources which make up the raw materials needed. It is the ability of some nations to produce what other nations want is what makes foreign trade work.
In some cases, the products produced in a foreign trade situation are very similar to other Products being produced around the world, at least in their raw form. Therefore, these products, known as commodities, are often pooled together in one mass market and sold. This is called trading commodities. The most common commodities often sold in foreign trade are oil and grain.
One of the issues considered when conducting foreign trade is protection of domestic trade and industries, by instituting tariffs, which are taxes on certain foreign goods. While this is a way to generate revenue, its real value lies in helping domestic companies. Another factor in foreign trade is currency issues. Some companies selling products overseas prefer to be paid in a certain type of currency, such as the US Dollar or Euro.
This protects the company in case the country involved in a trade experiences a rapid devaluation in currency. Besides protectionism, war is something that impedes trade as nations at war will not want to trade with each other. On the other hand, there are people who fight for free trade because they believe it would make the process of trade cheaper, while raising a nation’s standard of living.
Trading with other nations usually means profits. If one nation is better at making a certain item than another, then it would be cheaper and less time-consuming for them to make it than for another to have to train employees, garner the resources, and develop new production techniques in order to make enough just for themselves. Thus the opportunity costs are cheaper with trade. In most countries, foreign trade also represents a significant share of gross domestic product (GDP).
While international trade has been present throughout much of history, its economic, social, and political importance has been on the rise in recent centuries. Factors which have raised the magnitude of foreign trade are industrialization, advanced transportation, globalization, multinational corporations, and outsourcing. In fact, 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.
In principle, however, international trade is 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 labor are typically more mobile within a country than across countries. 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 imports goods from China that were produced with Chinese labor.
Traditionally trade was regulated through bilateral treaties between two nations. However, 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. Currently, 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.
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 as well as the potential benefit of favorable movements.
The history of foreign trade is fascinating. Europe pursued economic philosophies of mercantilism—that a nation should export more than it imports. By these philosophies, trade depended a lot on finding more natural resources. David Ricardo, a classical economist, in his principle of comparative advantage explained how trade can benefit all parties such as individuals, companies, and countries involved in it, as long as goods are produced with different relative costs. The net benefits from such activity are called gains from trade.
This is one of the most important concepts in international trade. Adam Smith, another classical economist, with the use of principle of absolute advantage demonstrated that a country could benefit from trade, if it has the least absolute cost of production of goods, i.e. per unit input yields a higher volume of output. He said that exporting and the profits it brought should be used to import things that people needed but could not produce or get themselves. The modern practices and processes of trade are shaped by this philosophy of practicality and fairness.
According to the principle of comparative advantage, benefits of trade are dependent on the opportunity cost of production. The opportunity cost of production of goods is the amount of production of one good reduced, to increase production of another good by one unit. A country with no absolute advantage in any product, i.e. the country is not the most competent producer for any goods, can still be benefited from focusing on export of goods for which it has the least opportunity cost of production.
Benefits of international trade can be reaped further, if there is a considerable decrease in barriers to trade in agriculture and manufactured goods. Some other important benefits of foreign trade are it enhances the domestic competitiveness, takes advantage of international trade technology, increases sales and profits, extends sales potential of the existing products, maintains cost competitiveness in domestic market, enhances potential for expansion of business, gains a global market share, reduces dependence on existing markets, and stabilizes seasonal market fluctuations.