International Trade Dynamics: Theories, Balances, and Exchange Rates

Posted on Jul 25, 2025 in Economy

International Trade Fundamentals

Defining International Trade

International trade is the exchange of goods and services between different countries.

Free Trade Principles

Free Trade: The absence of barriers to the exchange of goods and services between countries.

Economic Impact of Global Trade

• Companies are compelled to constantly innovate and adapt their behavior to remain competitive.
• Exports from countries with low production costs can influence developed economies.
• The bulk of world trade involves industrial products.
• Trade in services exhibits a very high growth rate.

Key Theories of International Trade

Mercantilist Theory

Mercantilist theory advocated for a continuous trade surplus, promoting active policies to restrict free trade and protect domestic production from imports.

Absolute Advantage Theory

The theory of absolute advantage advocates for free trade, suggesting that each country should specialize in producing only those goods it can produce most cheaply, and then purchase other goods from abroad.

Comparative Advantage Theory

The theory of comparative advantage demonstrated that the absolute advantage theory was incomplete, as the price at which a country specializes is not absolute, but relative.

Protectionist Measures in Trade

Common Trade Barriers

Countries implement obstacles to international trade through protectionist measures that restrict or distort it. Key measures include:

• Tariff: A tax imposed on goods imported from another country.
• Quotas: Limitations on the quantity of specific goods that can be imported.
• Measures with Equivalent Effect: These pose barriers to imports through complex procedures that ultimately reduce import volumes.
• Dumping: A measure by which a company sells its products at an artificially low price, often below production cost, to gain market share or eliminate competition.
• Grants or Subsidies: Financial assistance provided by a government to domestic industries, often to make them more competitive.

Balance of Payments & International Finance

Current and Capital Accounts

Balance of Current and Capital Accounts: For Spain, this balance has been negative for over 25 years, indicating that the country pays out more than it receives.

• The trade balance is often the primary component of the deficit.
• The balance of services is typically positive.
• Balance of Transfers: This was consistently positive until 2000.
• Balance of Capital: This has been positive since Spain’s entry into the EU.

Financial Account Dynamics

Financial Account Balance: Spain’s persistent deficit has led to a continuous need for international funding. This requires Spain to reduce domestic savings, borrow from abroad, or sell assets.

Understanding Balance of Payments

The theoretical sum of these balances should be zero. However, this is unusual in practice due to unrecorded movements, leading to an ‘errors and omissions’ entry in the balance of payments.

Speculation in Finance

Speculation: The act of manipulating economic levers for financial profit.

The International Financial System

International Financial System: A stable international financial system is crucial for global economic functioning. Established in 1944, the International Monetary Fund (IMF) ensures the proper functioning of the international financial system. Its duties include supervision, financial assistance, and technical support.

Why Purchase Foreign Exchange?

• Commercial Transactions.
• International Financial Operations.
• Mitigate currency exchange rate risk before transactions.
• For Speculation: To profit from future price increases.

Exchange Rate Dynamics

Factors Influencing Exchange Rates

International economic relations and exchange rate developments directly impact a country’s economic balance.

Impact of the Euro

Commercial and Financial Effects

• Commercial Effects:
  • Exports become more competitive.
  • Imports become cheaper.
• Financial Effects:
  • Downward pressure on interest rates.
  • Gains for foreign investors holding Euro-denominated assets.
  • Losses for European investors holding foreign currency assets.