International Trade and Balance of Payments

1. International Trade

1.1 Factors that Promote Trade Growth

  • Lack of resources domestically
  • Goods and services with lower costs in other countries

Absolute Advantage

A country trades with another country only if the goods supplied to it are at a lower price.

Comparative Advantage

Buying outside the national need for opportunity cost.

1.2 Protectionism

A set of measures adopted by a state to protect their merchandise or industries abroad.

Several Measures

  • Quotas: setting amounts
  • Subsidies to domestic production
  • Qualitative measures

1.3 Free Trade vs. Protectionism

Free Trade

Removal of barriers to international trade. Supporters argue for:

  • Increased production and employment
  • Improved price competition
  • Greater variety of products
  • Expansion of markets

Protectionism

  • Support national industries
  • Maintain national employment
  • Avoid unnecessary imports
  • Avoid dependence

1.4 The Current International Trade

Characteristics

  • Continued growth: trade between nations is constantly increasing
  • Shift in trade components: before exchange-based trading of physical goods, now with invisible goods (services)
  • Prominence of international enterprises
  • Inequality: rich countries exchange more valuable goods
  • Protectionism and economic power: rich countries with more advantages often have lower tariffs

2. The Balance of Payments

A document that records every economic operation that residents hold abroad in a year.

Current Account Balance

  • Business: Sales revenue (exports) and online shopping payments (imports)
  • Services: service transactions
  • Income: income and capital gains from abroad
  • Transfers: money that comes into the country

Balance of Financial Capital

  • On behalf of capital: e.g., Spain received € from the EU
  • For financial account: direct investment (buying), portfolio investment (equity)

Reservations

Money that a country can use to meet payments.

3. International Payments

3.1 Foreign Exchange

Foreign currency.

3.2 Supply and Demand of Currencies

  • Rental market: if demand increases, there will be more national currency
  • Relative prices: if there is less demand, the price increases and vice versa
  • Interest rates: if they increase, it attracts foreign investors
  • Exchange rate: if it is low, demand rises

Circumstances that Influence Currency Supply and Demand

  • Internal rent: if it increases, transactions performed outside a country also increase
  • Relative prices: if the domestic currency price increases, demand decreases
  • Interest rates: if they increase, it attracts investors due to higher returns
  • Exchange rate: if the exchange rate is low, demand increases, and vice versa

3.3 Exchange Rate Formation

It is the price, like any other property on the market, determined by supply and demand.

  • If there is more demand, the price increases; if there is excess supply, the price decreases

Appreciation

One currency increasing in value against another.

Depreciation

The opposite of appreciation.

3.4 Intervention in the Foreign Exchange Market

If a currency is very much appreciated, it has effects on other economies:

  • Exports become more expensive for overseas buyers
  • Imports increase

These two factors will cause or worsen the trade balance.

  • Investment increases in this country

In that case, the economic authorities may intervene in 4 ways:

  • Buy or sell currencies in the market
  • Limit the demand for foreign currencies
  • Implement economic policies that stabilize the price of the currency
  • Establish an exchange rate different from the market

Projects to Correct the Exchange Rate

  • Buy/sell currencies in the market: selling the foreign currency in the market to lower its price
  • Limit the demand for foreign currencies: ban or restrict the purchase of foreign products to prevent money from going abroad
  • Conduct economic policies that improve the overall situation and price of the currency: increasing taxes to reduce imports
  • Establish a different exchange rate from the market: Devaluation (lower the rate of the national currency against another). Revaluation (raise the currency value by the central bank)

3.5 Financial Speculation

Use of financial markets for buying and selling foreign exchange for returns.

3.6 Exchange Rate Systems

Monetary System

A set of rules/institutions organizing exchange markets and regulating international trade payments.

System of Flexible Exchange Rates

Letting the market determine the value of currencies.

4. Regional Integration

  • Preferential agreements: several countries with customs arrangements (e.g., ALADI)
  • Free trade zone: no tariffs between countries (e.g., NAFTA)
  • Customs Union: common tariff against third parties
  • Common Market: movement of workers and capital between member countries
  • Monetary Union: a common currency
  • Economic Union: coordinating economic policies of the states that comprise it