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WELCOME TO BUSINESS SCHOOL OF LOGISTICS AND SHIPPING

BSLS knowledge series

Trade Agreements and Barriers

LOGISTICS KNOWLEDGE SERIES-TRADE AGREEMENTS AND TRADE BARRIERS

Introduction to FTM

Hello everyone, I welcome you all to the foreign trade management course with business school of logistics and shipping. I am Shivaranjini faculty for foreign trade management. In this paper I am going to take you through the concepts of foreign trade, parties involved in international trade transactions, global organizations who are monitoring the flow of trade, trade agreements and their types, barriers to trade and how the foreign trade impacts the economy of a country, methods of payments in international transactions, international commercial terms and much more. Let’s get started.

What is foreign trade?

First let us understand what foreign trade is. We all know that there are different countries in the world each having different culture, laws, regulations, capabilities and resources. Due to such differences every country is capable of producing only a certain goods and services and therefore it is not able to meet the needs and demands of its consumers. For example country A which is rich in agricultural resources will be able to produce better agricultural products where as country B may be better at producing minerals and oils. Therefore clearly both the countries depend on each other to buy and sell the respective products in order to meet the requirements. This transaction and exchange of goods and services between two countries over international territories is referred as foreign trade. Foreign trade helps the countries to sell their products in the global markets. It helps the countries to satisfy and meet the demands of its consumers. Also, it helps the countries to offer options and choices to its consumers. For example a consumer in India can now choose between a German car, a Japanese car or an Indian car due to foreign trade. Countries engage in buying and selling of products such as clothes, food, medicines, machines etc or services such as consulting, banking, tourism and transportation and much more. A key point to note here is that countries not only engage in buying and selling of finished goods but also trade in intermediary goods meaning raw materials which are used in manufacturing processes. Manufacturers procure raw materials available at a cheaper price from the international market to be used in their manufacturing process and complete the finished goods.

Components of foreign trade

Foreign trade therefore helps countries to mutually benefit from each other and thereby contributing towards the economic growth and development. Foreign trade involves majorly 2 components namely the imports and the exports. When a country is buying from the outside world it is referred to as imports on the other hand when a country sells its products in the international market it is referred to as exports. Now let us understand the reasons for imports and exports by a country. First let us look at the major reasons for imports.

A country will import a product or a service from the outside world, when they do not have the capabilities or the resources to produce or manufacture the said products or service. Examples are specialized products, equipments, processes or technology. The second a country may engage in an import is when they are producing the said products and services however not in sufficient quantity so as to satisfy the needs and demands of its consumers. An example can be a country may be producing rice however not in sufficient quantity or volume so as to satisfy the demands of its people. In such a situation although the country is producing rice, they may have to import it from the outside world to satisfy their consumers. The third reason a country may engage in an import is when they are able to identify the products or services available at a cheaper price in the international markets. Examples can be procuring raw materials from the international market where they are available at a cheaper price to be used in the manufacturing process or outsourcing of business processes to places with availability of cheap labour. The last reason for a country to engage in import activities is to offer options and choices to its consumers. Examples are the different brands that are available in watches, cars, bikes, phones etc.

Reasons for exports

Now let us look at the reasons for exports. Countries engage in export activities when they are producing or manufacturing products best in class as available in international market. Examples may include specialized equipments, products, processes, technology etc. The second reason a country may engage in export processes is when they are producing or manufacturing a product in surplus meaning they are able to produce in such large quantities that they are able to satisfy the needs and demands of their local consumers and then also have excess which can be sold out in the international markets. Examples are the OPEC nations who are able to produce and export oil to many different countries around the world. The next reason for a country to engage in export activity is when they are able to identify huge demand for their products. Examples can be handicrafts, arts or artifacts.

Balance of Trade

Over the year’s factors such as globalization, industrialization, multinational companies and increased outsourcing activities has contributed to the increase in the scope of global trade. This transaction between the imports and exports of a country is referred as exim. The exim activity of a country is measured using the balance of trade. The BOT is the difference between the value of exports and the value of imports. By value we mean the monetary value of all the goods and services that have been exported or imported by a country over a specified period of time.

Balance of Trade continuation

In simple words the BOT represents how much a country has sold or bought from the outside world. Let us understand this with an example. Let us assume country A is exporting rice, pulses and minerals over a period of one year. Let us assume country A has exported rice for a value of about 5 million dollars, pulses for a value of about 2 million dollars and machines for a value of about 3 million dollars. Therefore the total value of exports for country A in one year equals to 10 million dollars. Now at the same time country A will also be importing products from the outside world. Let us assume, country A is importing cotton, cars and coffee. They have imported cars for a value of about 3 million dollars, cotton for a value of 2 million dollars and coffee for a value of about 2 million dollars. Therefore the total value of imports for country an over a period of one year equals to 7 million dollars. In this case the balance of trade hence becomes value of exports – value of imports which is equal to 3 million dollars. This represents the BOT of country A over a period of one year. The balance of trade can be positive or negative. A positive BOT is referred as a trade surplus while a negative BOT is referred as a trade deficit.

Balance of Trade representation

 Let us understand this with a representation. At any given point in time a country has both imports and exports. When a country exports its products or sells its products in the outside market it earns money or it earns foreign exchange. At the same time whenever a country is importing or buying products from the outside market, they have to spend money or spend foreign exchange, this value difference between imports and exports is referred as balance of trade. If the country’s imports are higher than the exports that is the country has been buying more which means they have spent more money it is referred as trade deficit and is represented as a negative balance of trade on the other hand if a country has more exports which means they have sold more to the outside world and earned more money in turn it is referred as trade surplus and is represented as a positive balance of trade. Ideally countries wish to maintain a positive balance of trade as it helps them to earn more foreign exchange.

Balance of Trade and GDP

The balance of trade is also a key determinant of the economic activity of a country as it is one of the key components of the GDP Gross Domestic Product. GDP represents the economic health of the country. It is also used to determine the size and growth of economy of a country. GDP as a tool is used by the policy makers, investors and businesses to make strategic decisions. The formula for GDP is private consumption + government investment + government spending + gross investment + the balance of trade which is the difference between the values of exports minus the value of imports and hence we can see how foreign trade has a direct impact on the economy of the country. A trade surplus that is a positive balance of trade represents as higher GDP whereas a trade deficit that is a negative balance of trade represents a lower GDP.

Benefits of Foreign Trade

Now let’s look at the benefits of foreign trade. Foreign trade enables countries to sell their products in the outside world, earn foreign exchange and thereby contribute towards economic growth and development. It also helps countries in achieving economic efficiency and productivity. Foreign trade enables countries to provide more options to its consumers and thereby satisfying consumer demand and needs. Foreign trade also increases the employment opportunities within a country as to produce more products you need more people. Finally foreign trade also helps countries in adapting new technology and processes and keep up to date with the market.

Introduction to trade agreements

As we have seen foreign trade involves countries with different rules, regulations and laws it is a complex process. Also, the distance between the countries increases the risk in the business. Therefore in order to bring stability and to define the terms of trade countries enter into certain contractual agreements known as the trade agreements.  Trade agreements outline terms and conditions of conducting business between the nations. Trade agreements reduce the risks and the misunderstandings amongst the member nations. Trade agreements aim to establish a safe and smooth flow of business transactions. Also the trade agreements provide scope for dispute resolution which may arise during the business transaction. Therefore trade agreements help to increase confidence between the parties engaged and thereby enhance the economic cooperation and integration between the countries.

Trade agreements representation

As we can see there are two countries country A and country B, in both the countries there are a set of sellers and buyers. The sellers are represented by the letter S and the buyers are represented by the letter B. Trade agreements aim to enable easy and safe business transactions between both the countries. The sellers are known as exporters and the buyers are known as importers. Ideally countries prefer a free flow of goods and services between their borders. However to avoid certain situations and risks countries tend to impose certain restrictions or obstacles in the forms of tariffs, quotas etc which basically prevent the free flow of trade between them

 Trade Agreement types

The most common types of trade agreements are the free trade agreement and the preferential trade agreement. A free trade agreement enables the countries to abolish the trade restrictions in the form of tariffs and quotas applicable on the products being traded between them. On the other hand a preferential trade agreement does not allow countries to abolish restrictions however enables them to lower the tariffs or quotas as applicable on the products that are being traded. Depending on the number of countries participating trade agreements are broadly classified as bilateral and multilateral.

When two countries engage in a trade agreement it is referred as a bilateral trade agreement examples are India- Japan and India – Srilanka.  On the other hand when there are more than 2 countries involved in a trade agreement it is referred to as a multilateral trade agreements. Examples are ASEAN and SAARC.

India Japan Trade Agreement Example

Let us see an example of the trade agreement between India and Japan.

Introduction to trade barriers

As much as governments encourage foreign trade for the mutual benefit, growth and development, it is also their responsibility to protect and promote the domestic markets. Allowing more foreign products into the country can destroy the domestic markets. Also, as government continues to buy products or import products from the outside world their spending also increases. There to protect the local markets from such threats and also to cut down on the money spent due to imports; government imposes certain restrictions and obstacles on the free flow of trade. These restrictions or obstacles are referred as trade barriers. Certain trade barriers used by the government to control the flow of trade are tariffs, non-tariffs, quotas, anti dumping duties, embargoes and sanctions. Let us understand each one of them.

Tariffs

The first trade barrier that we are going to discuss is called as tariffs. Tariffs are taxes that are imposed by the government on the products that are imported into a country. Tariffs tend to increase the price of the product and thereby reducing its sales in the domestic market. When the cost of the product goes high the number of people buying the product goes down. We can see this in the higher prices of the imported cars and bikes that are available in the market. This is because of the tariffs that are imposed by the government on the prices of these bikes and cars which ultimately make the overall costs of the products higher. Due to such high costs many consumers prefer to buy from the domestic players. Therefore we can see how government uses tariff as a trade barrier to protect the domestic players.

Non-tariffs

The next type of trade barrier is called as non-tariffs. Non – tariffs do not impose any kind of taxes on the products that are being imported, however they do specify certain qualitative criteria such as technical specifications, colour, size, testing, certifications, rules of origin etc. Products which confirm to such qualitative criteria are only allowed to be imported into the country while the others are rejected.

Subsidies

One of the forms of non-tariff trade barriers used by the government is called as subsidies. Subsidies are benefits or incentives that are offered by the governments to the domestic players in the form of low interest loans, financial assistance or tax benefits to help them to keep their prices competitive in the domestic markets.

Quotas

The next trade barrier that we are going to discuss is called as quotas. Quotas do not impose any tariffs on the products and services that are being imported or exported out of a Country; however quotas do limit the quantity or sometimes the value of the goods that are being traded. Government imposes quotas to reduce the quantity of competitive products available in the local markets and thereby increasing the demand for the domestic goods and services. Quotas are an effective trade barrier than tariffs in cases where the demand for a product is not price sensitive. Example India has import quota on pulses and US has import quota on sugars.

Anti-dumping duty

To protect the domestic players and the markets from the threat of foreign trade governments use another effective trade barrier called as the antidumping duty. To understand the antidumping duty first let us understand the process of dumping. Sometimes manufacturers in one country try to sell their products in another country at a much lower price than the normal price that is available in the other country. Example let us assume the price of a product is 3 dollars in country A but when country B tries to sell the same product for 1 dollar in country A then such a practice is called as dumping. Manufacturers engage in the act of dumping to increase the product market share in the foreign territories and also to drive our local competition.

Anti – dumping duty

To counter such practices, government imposes the anti dumping duty on the imported products. An example here would be when the Chinese steel manufacturers tried to sell their steel at a much lower price in the US domestic markets causing damage of business to the domestic steel manufacturers. Upon representation by the domestic steel manufacturers, the US government then imposed high antidumping duties ranging between 200%-500% on the imported steel from China. By doing so the government could safeguard and protect the domestic steel manufacturers in the US.

Embargoes and Sanctions

Now let us discuss embargoes and sanctions. Embargoes and sanctions area political trade restrictions put in place against a country with an aim to maintain and restore international peace and security. Embargoes are barriers which completely ban or prohibit any kind of trade between two countries. Sanctions on the other hand do not completely ban however prohibit trade in certain areas of goods, services or technology depending on various reasons.

Benefits of trade barriers Finally let us look at the benefits of trade barriers. By imposing trade barriers governments are able to protect the local and the domestic markets. By imposing trade barriers governments are able to restrict imports and thereby also restrict the flow of foreign exchange out of the country. Government is able to monetise more revenue by imposing duties and taxes on imports. Government is also able to protect the country from dumping practices and finally by promoting more domestic production government is able to make a strong and efficient economy.

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