Factors That Led to Development of World Merchandise Trade - Essay Example

Qn Factors that led to development of world Merchandise trade between 2002 and Tariffs reduction The consistent growth in world merchandise trade between 2002 and 2010 has been one of the striking developments in the global economy over the past decade. Mundell (1957) argue that tariff reductions are the most significant drivers of global trade growth. However, Yi (2003) disputes the decline in absolute tariffs amongst largest global economies as it is implied that modern tariffs cannot match the extent and nature of growth in world trade, posing a qualitative and quantitative puzzle for international trade theory. To counter the effects of tariffs, countries started forming trading blocs, which largely contributed to their elimination. These barriers have overtime been significantly eliminated through bilateral and multilateral trade agreements. Relative factor endowment Classical trade theory, however, predicts that countries specialize in production of commodities which best suits their relative factor endowment. This kind of specialization gives rise to advantage in international trade in merchandise. According to classical trade theory, differences in relative factor endowments cause factors of production specialization causing trade in international markets. Trade theory further expounds that, trade in commodities with varying factor intensities may eliminate local diminishing returns to factors of production and thus the need for capital to flow across the boundaries (Lerner 1952). From another standpoint, Leontief (1954) viewed international commodity trade from the perspective of differences in regional factor proportions such as source of comparative advantage. He argues that different parts of the world have differing intensive intermediate goods and every region specialize in particular type of commodity, which uses their abundant factor intensity Reduced cost of trade and increased income Reduction in cost of trade includes transportation, currency exchange and communication also contributed to rise in global commodity trade. Increase in income per head is also another factor that increases cross- border trade. As income per head increases, consumers tend to switch their spending habits away from basic to manufactured commodities, which on the other hand offer more scope for product diversification, differentiation and international trade. The classical trade model stipulates that countries would prefer to produce commodities that are relatively cheaper for them to produce. Factors that led to decline in world Merchandise trade between 2008 and 2009 Weaker Global economic growth The weak economic growth mostly amongst the developed economies is one of the major factors that contributed to the sharp decline of the world merchandise trade within this duration. Trade recorded a sharp decline of 23% as the level of trade volume remained well below the baseline. This situation was further complicated during the global trade crisis when the imports of least developed economies drifted to about 13% below the baseline. Such below the trend performance of the global trade was attributed to the weak import demand in advanced economies. However, the shift in the global trade could also be associated with the rapid industrial growth in a number of developing countries. Spread of global supply chains and product composition of trade to output Notably, global supply chains facilitate goods movement across the borders during the production process, which in turn raises world trade flows. The products, which were heavily affected, were the merchandise which had a significant share in world trade that negatively affected the volume of global trade. The major effect of the slump in cross border trade is raised product prices. Further, negative trends in world trade affected the economic recovery. Curtailment of economic stimulus measures Curtailment of economic stimulus is one of the factors that dampened economic activities. For instance, European governments moved towards fiscal consolidation in an attempt to reduce their budget deficits through a combination of revenue measures and spending cuts (Hummels 2007). These measures resulted to significant reduction in cross border trade. Persistent unemployment Persistent unemployment adversely affected domestic consumption. Low incomes caused contraction in import demand. When people incomes are low, their purchasing power dampens, which on the other hand contracts import demand thereby affecting world trade. Grossman and Razin (1984) observed that weakening import demand of the developed economies formed one of the major reasons for the slowdown in world merchandise trade in 2008/2009. In the US, drifting of the global trade weakened as a result of sluggish domestic demand coupled with weakening dollar. In Europe and Japan, deceleration of imports volumes was mainly attributed to reduced demand for investment goods. As explained by the classical theory of labor markets, elimination of any labor surplus through reduction in wages affects commodity demand adversely as the consumer purchasing power, if adversely weakened. The consumers are only left to purchase the basic necessities. As such, the demand for other imported manufactured products dampens. Qn. 2) Free Trade area Though free trade leads to cheap commodities, it is also true that it leads to job losses. Many household can take advantage of cheap and more efficient commodities courtesy of free trade, but the pain endured by households who lost jobs may be greater than the overall benefit enjoyed, hence, the reason that labor unions will always fight vigorously to keep their members’ jobs (Helpman 1999). There has been a heated debate that free trade leads to job exportation as the production of commodities takes place in the country where it is least expensive. The argument of money leaving the country is well explained by mercantilism in economic theory, which stipulates that international trade creates wealth for a nation. The mercantilists believed that exports should be encouraged and imports discouraged while at the same time hoarding gold. They were of the view that this will accumulate wealth for a nation with minimal outflow to other nations. Another argument revolves around quality as imported goods are said to be inferior, therefore, they could afford to sell at lower prices. Dumping, which occurs when producers sells goods in a foreign market at a price lower than the price in domestic market, or lower than production cost is another major concern. The sole objective of his behavior is to drive domestic producer out of market after which the dumping firm raises the commodity prices. This behavior puts the country at risk as it kills domestic firms, hurting the host country economy. Therefore, it is true even as of today, according to the decision of Lord Macaulay (1800-1859), when he mentioned that, “Free trade, one of the greatest blessings which a government can confer on its people, is in almost every country unpopular.” 2(a) Non Tariff Barriers Non- tariff barriers refer to any policy applied by the government to discourage imports, other than the usual tariffs on imports. Non -tariff barriers takes many forms, such as discriminatory product standards, importation quotas, buy at home rules for government purchases and administrative red tapes, to harass importers of foreign products. Non- tariff barriers reduces imports through limiting the quantity of products imported. Discussed below is a few of non –tariff barriers. The Importation quota Importation quota is the best known non- tariff barrier. It refers to an imposition of a limit on the total quantity that can be imported into a country during a specified period of time. The government prefers using the quota as it makes sure that the size of imports is firmly restricted. In addition, it gives the government greater power as the officials bears the administrative authority over who gets the importation license under a quota system. Voluntary export restraints (VERs) The export restraint requires the foreign exporting firm to act like a cartel, rising prices and restricting sales. Therefore, through VER, the importing country allows the foreigners monopolist power and forces them to accept it and calls for their compliance voluntarily. VER is used by large economies to guard their industries that are facing trouble competing against the rising tide of imports. With VER, the exporting country government allocates licenses to export specified quantities to its producers. However, the export producers should realize that there is less incentives to compete amongst themselves to export. Product standards Other non- tariff barriers include laws and regulations regarding the product quality that is either enforced in names of health, safety, sanitation or environment. Such standards are in most cases tailored to fit local standards and require costly modifications for foreign products to meet. More so, testing and verification procedures are made to be too expensive just to bar entry of foreign commodities. 2 (b) Balance of payments Current accounts Balance of payment accounts refers to the accounting records of all monetary dealings of a country and the rest of the world. These transactions include payment of country’s exports and imports and also other financial transfers. All the components of BOP accounts must sum up to zero with neither deficit nor a surplus. If a country imports more than it exports, for instance, this case of Pakistan, the current account will be in deficit, but this balance need to be offset in other ways such as through earnings from foreign investments if there are any. This is achieved by running central bank reserves or receiving loans from friendly nations (Leamer 2004). According to the data provided, the current account can be said to be in deficit as source of funds (exports) are less as compared to use of funds for this matter represented by imports. Considering that there is no other information given regarding other sources of funds, then it can be concluded that Pakistan’s current account is in deficit. Correction of BOP imbalances (deficit) Changing the exchange rate Depreciation of currency makes imports expensive for the citizens, thus helping correct BOP deficit, though this solution does not bear immediate positive impact due to Marshal- Lener condition which states that, for a currency devaluation to bear a positive impact on trade balance, then sum of price elasticity for both imports and exports must be a value more than one. Exchange rates are usually adjusted by the government in managed currency regime and even where left to float freely, they tend to follow direction that will restore balance. Pakistan is importing more, thus, the value of its currency in the international market tends to rise as it tries to exchange for foreign currency to make payments for the imports. Adjusting internal prices and demand Where the exchange rates are fixed, trade imbalances exist between concerned member countries. Under this option, a country that has adverse BOP will experience net loss in gold. Prices will be reduced making its exports more competitive, thus correcting the imbalance. The gold standard was considered successful until 1914 and thereafter correction by deflation to the required degree seemed to be the best option. Government policy Government policy can be used to check negative BOP. The government can come up with protectionist trade policies as a way of making imports more expensive. The government can achieve this by levying tariffs or taxes on imported commodities. This will make imports more expensive to the locals, who will instead be forced to buy locally manufactured goods at the expense of imported ones. This will help in reducing balance of payments deficit. Trading countries may also enter in to trade agreements with each other, whereby they give each other preferred treatment for importation purposes. Such actions will have an impact on BOP situation. Qn. 3) Free on Board (FOB) Free on board is a shipping term which indicates that the commodity supplier caters for the shipping costs (inclusive of the insurance cost) from the point of manufacture to the specified destination from where the buyer takes responsibility. Thus, the price quoted by the seller includes all charges from placing the goods on board at the port to the destination of the buyer. Cost Insurance and Freight (CIF) This is a term requiring the seller to organize for transportation of goods by sea to the port of destination whereby he issues buyer with the concerned documents, to facilitate obtaining of the goods from the carrier. It is a contract regarding international transportation that describes such matters as time, payment, place of delivery and also stipulates the transfer of risk of loss from the seller to the buyer, and also the party to bear costs of freight and insurance. Direct Duty Paid (DDP) This term is used in any mode of transport. With DDP, the seller is responsible for all import customs formalities and also duty for final delivery of goods to the buyer at the specified place of delivery. In short, the buyer carries no risk for the goods until they are availed to him at the specified destination, which is normally the buyer’s premise. . References Grossman, M & Razin, A 1984, ‘International Capital Movements under Uncertainty’, Journal of Political Economy, 9(2), pp.286-306. Helpman, E 1999, ‘The Structure of Foreign Trade,’ Journal of Economic Perspectives, 13(2), pp.121-144. Hummels, D 2007, ‘Transportation Costs and International Trade in the Second Era of Globalization,’ Journal of Economic Perspectives, 21(3), pp.131-154. Leamer, E 2004, Sources of Comparative Advantage: Theory and Evidence, MIT Press, Cambridge. Leontief, W 1954, ‘Domestic Production and Foreign Trade: The American Capital Position Re- examined’, Economica Internazionale ,7(5), pp. 9-36. Lerner, A 1952, ‘Factor Prices and International Trade,’ Economica, 19(4), pp. 1-15. Mundell, R 1957, ‘International Trade and Factor Mobility,’ American Economic Review, 47(2), pp. 321-335. Sachs, D & Warner, A 1995, ‘Economic Reform and the Process of Global Integration’, Journal on Economic Activity, 1(6), pp.1–118. Yi, K 2003, ‘Can Vertical Specialization Explain the Growth of World Trade?’ Journal of Political Economy, 111(3), pp. 52-102. Read More