International trade, in its simplest sense, is the exchange of goods

and services between countries. In other words, international trade is

exchange of capital, goods, and services across international borders or
territories. In most countries, it 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. Industrialization, advanced
transportation, globalization, multinational corporations, and outsourcing
are all having a major impact on the international trade system.
International trade is also a branch of economics, which, together with
international finance, forms the larger branch of international economics.
International trade gives rise to a world economy, in which prices, or supply
and demand, affect and are affected by global events. For example, political
change in Asia could result in an increase in the cost of labor, thereby
increasing the manufacturing costs for an American shoe company based in
India, which would then result in an increase in its price.
Thus, international trade is the economic interaction among
different nations involving the exchange of goods and services, that is,
exports and imports. The guiding principle of international trade is
comparative advantage, which indicates that every country, no matter their
level of development, can find something that it can produce cheaper than
another country. International finance, the study of payments between
nations, is a related area of international economics.
International trade is in principle not different from domestic trade
as the motivation and the behavior of parties involved in a trade does not
change fundamentally depending on 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 a different

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. Thus international trade is mostly
restricted to trade in goods and services, and only to a lesser extent to trade
in capital, labor or other factors of production.
In political economy, international trade has another meaning. In
technical sense, international trade is distinguished from home trade by the
existence of barriers which prevent owners of the means of production in
one region from employing those means in another region. However, the
general conditions which determine equilibrium are the same for both
domestic and foreign trade; the only difference is that in the case of home
trade there are a few more equations. Increasing international trade is
crucial to the continuance of globalization. International trade is a major
source of economic revenue for any nation that is considered a world power.
Without international trade, nations would be limited to the goods and
services produced within their own borders. Trading globally gives
consumers and countries the opportunity to be exposed to goods and
services not available in their own countries. Almost every kind of product
can now be found on the international market. Services are also traded:
tourism, banking, consulting and transportation.
Countries all over the world need to participate in international
trade to make up various deficiencies and obtain resources necessary to
produce goods and services desired by the citizens of the country. A country
may export raw materials in exchange of processed foods and finished
products of another country. The three basic components of trade are
capital, labor and land.
Leading industrial based countries like Japan and Germany
produce a large quantity of capital intensive products like heavy
construction equipment, industrial machinery and cars. This is because of
shortage of available land; Japan is more concerned with capital - intensive
production, instead of land-intensive production. The countries that have
relatively low labor costs, stress on producing labor-intensive commodities

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Concept of International Trade

1.1 Benefits of International Trade

The economic, political, and social significance of international
trade has been theorized in the Industrial Age. The rise in the international
trade is essential for the growth of globalization. The restrictions to
international trade would limit the nations to the services and goods
produced within its territories, and they would lose out on the valuable
revenue from the global trade.
The benefits of international trade have been the major drivers of
growth for the last half of the 20th century. Nations with strong
international trade have become prosperous and have the power to control
the world economy. The global trade can become one of the major
contributors
to
the
reduction
of
poverty.
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 (see section 1.3.1 below).
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.
International trade leads to higher efficiency. Global trade allows
wealthy countries to use their resources - whether labor, technology or
capital - more efficiently. Because countries are endowed with different
assets and natural resources (land, labor, capital and technology), some
countries may produce the same good more efficiently and therefore sell it
more cheaply than other countries. If a country cannot efficiently produce

an item, it can obtain the item by trading with another country that can. This
is known as specialization in international trade. International trade not only
results in increased efficiency but also allows countries to participate in a
global economy, encouraging the opportunity of foreign direct investment
(FDI), which is the amount of money that individuals invest into foreign
companies and other assets. In theory, economies can therefore grow more
efficiently and can more easily become competitive economic participants.
For the receiving government, FDI is a means by which foreign currency
and expertise can enter the country. These raise employment levels and lead
to a growth in the gross domestic product. For the investor, FDI offers
company expansion and growth, which means higher revenues.
To understand the role of foreign trade in the Indian economy, one
has to understand the importance of foreign trade for any country. This can
be explained with a simple example: Imagine that there are only two
countries in the world, India and Denmark. Both countries have 1,000
citizens. These citizens eat only bananas and drink only milk. Each country
needs 50,000 bananas and 50,000 liters of milk to feed its population. In
India, the weather is good; the sun shines a lot so bananas grow easily.
Therefore, one Indian can produce 100 bananas per year. But India is also a
dry country, so the cows in India don't produce much milk. Therefore, India
can only produce 50 liters of milk per year. In Denmark, the weather is not
sunny, so bananas don't grow easily. Therefore, one Dane can only produce
50 bananas per year. On the other hand is Denmark a perfect place for cows,
because it is a very green country. Therefore, Denmark can produce 100
liters of milk per year. Suppose that there is no foreign trade between India
and Denmark. Denmark will produce 50,000 liters of milk and will use 500
inhabitants to do this. The other 500 Danes will be used to produce bananas,
resulting in a production of 25,000 bananas (500 workers x 50 bananas per
worker). So Denmark will come 25,000 bananas short to feed its
population. India will produce 50,000 bananas (using 500 workers) and
25,000 liters of milk (using the other 500 workers), and also India will not
be able to feed its population. So without foreign trade, both countries will
not be able to produce enough food for the population.

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like clothing, shoes and other consumable goods. Indonesia and China are
the examples of labor-intensive producing countries.

This example makes two things clear: One, foreign trade is for the
benefit of all countries. Two, when there is foreign trade; every country will
specialize in the production of those goods in which it has an advantage to
produce them.
In India, the role of foreign trade is easy to determine: First of all,
foreign trade has made India richer. Products which are difficult to produce
for India can be imported, which is good for the Indian economy. Second
and this is without doubt the biggest influence on the Indian economy, the
rise of foreign trade has forced India to specialize in the production of a few
goods. These are mainly ores (the Indian mines), food products and cheap
products that are easily built using cheap labor. So India has been one of
those countries which compete with other economies by producing laborintensive products. This has had a great influence on Indian economy,
because it implies a partial shift from agriculture to industrial production.
As it opens up the opportunity for specialization and therefore
more efficient use of resources, international trade has potential to
maximize a country's capacity to produce and acquire goods. Opponents of
global free trade have argued, however, that international trade still allows
for inefficiencies that leave developing nations compromised. What is
certain is that the global economy is in a state of continual change and, as it
develops, so too must all of its participants.
Thus the benefits of international trade can be summarized as
follows:

Enhances the domestic competitiveness

Takes advantage of international trade technology
Increase sales and profits
Extends sales potential of the existing products
Maintains cost competitiveness in the domestic market
Enhances potential for expansion of your business
Gains a global market share
Reduces dependence on existing markets
Stabilizes seasonal market fluctuations

International Trade has positively influenced the economic growth of a

country in the following ways:

International trade injects global competitiveness and hence the

domestic business units tend to become very efficient being
exposed international competition. Due to the integration with the
world economy the entrepreneurs can have easy access to the
technological innovations. They can utilize the latest technologies
to enhance their productivity.

The developing countries have higher trade protectionism

measures as compared to the developed countries. The countries
that have adopted such measures are seen to reap the benefits of an
open trade regime.

The products that are labor intensive like clothing, footwear,

textiles etc are exported by the developing countries to both,
developed and underdeveloped countries. Such exports earn heavy
tax revenue in countries like Mexico, India, China and many more.

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Now suppose that there is foreign trade between India and

Denmark. Both countries can produce the goods that they are best in,
bananas for India and milk for Denmark. The 1000 workers in India will be
able to produce 100,000 bananas. They only need 50,000 so the other
50,000 will be exported to Denmark. The 1000 workers in Denmark will be
able to produce 100,000 liters of milk. They only need 50,000 liters, so the
other 50,000 liters will be exported to India. As a result of this foreign trade,
both countries will have enough food to feed their population.

International Trade has also brought in a reduction in the poverty

level. India was a closed economy in the 1960s and 70s. There was
not even 1% decline in the poverty level. The entire scenario
changed with globalization and international trade. According to
Prof. Jag dish Bhagwati the reduction in the poverty level is due to
a pull up rather than a trickle down effect. The economic
growth brought about by international trade can generate financial
resources. Such resources can be used to set up anti poverty
programs. Better education and health facilities can also be
provided to the poor.
The exclusion of all types of trade barriers in the agricultural
products of the developed countries will lead to a decline and rise
in production and world prices respectively. The developing
countries profit by selling or exporting these products at escalated
world prices.

International trade has exerted profound influence on the economic

growth of countries. It has been observed that with the opening up of the
economy and liberalization of trade restrictions, the developing countries,
especially India and China, have grown over the years.
Factors affecting International Trade
Over time a nation's work force will change, and thus the goods
and services that nation produces and exports will change. Nations that train
their workers for future roles can minimize the difficulty of making a
transition to a new, dominant market. The United States, for example, was
the dominant world manufacturer from the end of World War II until the
early 1970s. But, beginning in the 1970s, other countries started to produce
finished products more cheaply and efficiently than the United States,
causing U.S. manufacturing output and exports to drop significantly.
However, rapid growth in computer technology began to provide a major
export for the United States.

Thus, there are various factors that affect international trade. Some
of them are discussed hereunder:
1.3.1 Economic Environment
An important factor influencing international trade is taxes. Of the
different taxes that can be applied to imported goods, the most common is a
tariff, which is generally defined as an excise tax imposed on imported
goods. A country can have several reasons for imposing a tariff. For
example, a revenue tariff may be applied to an imported product that is also
produced domestically. The primary reason for this type of tariff is to
generate revenue that can be used later by the government for a variety of
purposes. This tariff is normally set at a low level and is usually not
considered a threat to international trade. When domestic manufacturers in a
particular industry are at a disadvantage, vis--vis imports, the government
can impose what is called a protective tariff. This type of tariff is designed
to make foreign products more expensive than domestic products and, as a
result, protect domestic companies. A protective tariff is normally very
popular with the affected domestic companies and their workers because
they benefit most directly from it.
In retaliation, a country that is affected by a protective tariff will
frequently enact a tariff of its own on a product from the original tariff
enacting country. In 1930, for example, the U.S. Congress passed the
Smoot-Hawley Tariff Act, which provided the means for placing protective
tariffs on imports. The United States imposed this protective tariff on a wide
variety of products in an attempt to help protect domestic producers from
foreign competition. This legislation was very popular in the United States,
because the Great Depression had just begun, and the tariff was seen as
helping U.S. workers. However, the tariff caused immediate retaliation by
other countries, which immediately imposed protective tariffs of their own
on U.S. products. As a result of these protective tariffs, world trade was
severely reduced for nearly all countries, causing the wealth of each
affected nation to drop, and increasing unemployment in most countries.
Realizing that the 1930 tariffs were a mistake, Congress took corrective

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Another form of a trade barrier that a country can employ to

protect domestic companies is an import quota, which strictly limits the
amount of a particular product that a foreign country can export to the
quota-enacting country. For example, the United States had threatened to
limit the number of cars imported from Japan. However, Japan agreed to
voluntary export quotas, formally known as "voluntary export restrictions,"
to avoid U.S. imposed import quotas. The power of import quotas has
diminished because foreign manufacturers have started building plants in
the countries to which they had previously exported in order to avoid such
regulations.
A government can also use a nontariff barrier to help protect
domestic companies. A nontariff barrier usually refers to government
requirements for licenses, permits, or significant amounts of paperwork in
order to allow imports into its country. This tactic often increases the price
of the imported product, slows down delivery, and creates frustration for the
exporting country. The end goal is that many foreign companies will not
bother to export their products to those markets because of the added cost
and aggravation. Japan and several European countries have frequently used
this strategy to limit the number of imported products.
1.3.2 Political Environment
Each country varies regarding international trade and relocation of
foreign plants on its native soil. Some countries openly court foreign
companies and encourage them to invest in their country by offering
reduced taxes or some other investment incentives. Other countries impose
strict regulations that can cause large companies to leave and open a plant in
a country that provides more favorable operating conditions. When a

company decides to conduct business in another country, it should also

consider the political stability of the host country's government. Unstable
leadership can create significant problems in recouping profits if the
government falls of the host country and/or changes its policy towards
foreign trade and investment. Political instability is often caused by severe
economic conditions that result in civil unrest.
Another key aspect of international trade is paying for a product in
a foreign currency. This practice can create potential problems for a
company, since any currency is subject to price fluctuation. A company
could lose money if the value of the foreign currency is reduced before it
can be exchanged into the desired currency. Another issue regarding
currency is that some nations do not have the necessary cash. Instead, they
engage in counter trade, which involves the direct or indirect exchange of
goods for other goods instead of for cash. Counter trade follows the same
principles as bartering, a practice that stretches back into prehistory. A car
company might trade new cars to a foreign government in exchange for
high-quality steel that would be more costly to buy on the open market. The
company can then use the steel to produce new cars for sale.
In a more extreme case, some countries do not want to engage in
free trade with other nations, a choice known as self-sufficiency. There are
many reasons for this choice, but the most important is the existence of
strong political beliefs. For example, the former Soviet Union and its
communist allies traded only with each other because the Soviet Union
feared that Western countries would attempt to control their governments
through trade. Self-sufficiency allowed the Soviet Union and its allies to
avoid that possibility. However, these self-imposed trade restrictions created
a shortage of products that could not be produced among the group, making
the overall quality of life within the Soviet bloc substantially lower than in
the West since consumer demand could not be met. When the Berlin Wall
came down, trade with the West was resumed, and the shortage of products
was reduced or eliminated.

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action by passing the Reciprocal Trade Agreements Act of 1934, which

empowered the president to reduce tariffs by 50 percent on goods from any
other country that would agree to similar tariff reductions. The goal was to
promote more international trade and helps establish more cooperation
among exporting countries.

Before a corporation begins exporting products to other countries,

it must first examine the norms, taboos, and values of those countries. This
information can be critical to the successful introduction of a product into a
particular country and will influence how it is sold and/or marketed. Such
information can prevent cultural blunders, such as the one General Motors
committed when trying to sell its Chevy Nova in Spanish-speaking
countries. Nova, in Spanish, means "doesn't go" and few people would
purchase a car named "doesn't go." This marketing error, resulting simply
from ignorance of the Spanish language, cost General Motors millions in
initial sales as well as considerable embarrassment.
Business professionals also need to be aware of foreign customs
regarding standard business practices. For example, people from some
countries like to sit or stand very close when conducting business. In
contrast, people from other countries want to maintain a spatial distance
between them and the people with whom they are conducting business.
Thus, before business-people travel overseas, they must be given training
on how to conduct business in the country to which they are traveling.
Business professionals also run into another practice that occurs in
some countries bribery. The practice of bribery is common in several
countries and is considered a normal business practice. If the bribe is not
paid to a businessperson from a country where bribery is expected, a
transaction is unlikely to occur. Laws in some countries prohibit
businesspeople from paying or accepting bribes. As a result, navigating this
legal and cultural thicket must be done very carefully in order to maintain
full compliance with the law.
1.3.4 Physical Environment
Other factors that influence international trading activities are
related to the physical environment. Natural physical features, such as
mountains and rivers, and human-made structures, such as bridges and

roads, can have an impact on international trading activities. For example, a

large number of potential customers may live in a country where natural
physical barriers, such as mountains and rivers, make getting the product to
market nearly impossible.
1.4 Regulation of International Trade
As with other theories, there are opposing views for regulation of
international trade. International trade has two contrasting views regarding
the level of control placed on trade:
(1)
(2)

Free trade and

Protectionism

Free trade is the simpler of the two theories: a laissez-faire

approach, with no restrictions on trade. The main idea is that supply and
demand factors, operating on a global scale, will ensure that production
happens efficiently. Therefore, nothing needs to be done to protect or
promote trade and growth because market forces will do so automatically.
In contrast, protectionism holds that regulation of international trade is
important to ensure that markets function properly. Advocates of this theory
believe that market inefficiencies may hamper the benefits of international
trade and they aim to guide the market accordingly. Protectionism exists in
many different forms, but the most common are tariffs, subsidies and
quotas. These strategies attempt to correct any inefficiency in the
international market.
Free trade is usually most strongly supported by the most
economically powerful nations, though they often engage in selective
protectionism for those industries which are strategically important such as
the protective tariffs applied to agriculture by the United States and Europe.
Free trade is usually most strongly supported by the most economically
powerful nation in the world. The Netherlands and the United Kingdom
were both strong advocates of free trade when they were economically
dominant, today the United States, the United Kingdom, Australia and

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1.3.3 Cultural Environment

Traditionally agricultural interests are usually in favor of free trade

while manufacturing sectors often support protectionism. This has changed
somewhat in recent years, however. In fact, agricultural lobbies, particularly
in the United States, Europe and Japan, are chiefly responsible for particular
rules in the major international trade treaties which allow for more
protectionist measures in agriculture than for most other goods and services.
During recessions, there is often strong domestic pressure to increase tariffs
to protect domestic industries. This occurred around the world during the
Great Depression. Many economists have attempted to portray tariffs as the
underlining reason behind the collapse in world trade that many believe
seriously deepened the depression.

in place, the government curbs consumer rights to enjoy competition in the

market.
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 NAFTA between
the United States, Canada and Mexico, and the European Union between 27
independent states. However, the 2005 Buenos Aires talks on the planned
establishment of the Free Trade Area of the Americas (FTAA) failed largely
because of opposition from the populations of Latin American nations.
Similar agreements such as the Multilateral Agreement on Investment
(MAI) have also failed in recent years.
1.4.1 Fair Trade
The concept of fair trade has gained substantial importance in the
todays world market. It is a kind of social movement, which is aimed at
ensuring fair trade deal for the producers of less developed and developing
nations. Proper working environment, fair prices for products and services,
producers security, consistent demand for products, and many other related
factors come under the purview of fair trade. It helps to promote exports
from developing to developed nations. Fair trade practices are designed to
ensure economic sustainability all over the world.

In times of flourishing international trade, imposing trade barriers

prevents the nation from fully realizing the economic benefits of such
globalized trade. A protectionism regime causes over-allocation of resources
in the protected sector and exploitation or under-allocation of resources in
free trade sectors. This usually leads the country into economic
disequilibrium, which hampers growth.

It was in the 1940s and 1950s that several non-governmental

organizations and some religious groups took the initiative to bring fair
trade into practice. During this period, NGOs like Ten Thousand Villages
and non-profit organizations like SERRV International, tried to create fair
trade supply chains involving all the developing nations in the world.

Import restrictions affect international trade relations, which in

turn leads to a decline in exports. Thus, the protectionism regime that is
employed to protect certain sectors actually tends to retard the growth of the
entire economy. Free trade environments offer greater and better choices in
the market, leading to enhanced consumer satisfaction. With trade barriers

The present form of fair trade practices became operational in the

1960s and within the decade of 1970s the concept of fair trade became
immensely popular in the international arena. The fair trade movement has
proved to be of great use in bringing the producers of less developed nations
to the mainstream of the world economy.

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Japan are its greatest proponents. Communist and socialist nations often
believe in autarchy, a complete lack of international trade. Fascist and other
authoritarian governments have also placed great emphasis on selfsufficiency. No nation can meet all of its people's needs, however, and every
state engages in at least some trade. Countries such as India, China and
Russia are increasingly becoming advocates of free trade as they become
more economically powerful themselves. As tariff levels fall there is also an
increasing willingness to negotiate non tariff measures, including foreign
direct investment, procurement and trade facilitation. The latter looks at the
transaction cost associated with meeting trade and customs procedures.

Free trade has existed from the time man learned to barter, much
before the concept of actual money and currency materialized. Now, it
refers to the movement of goods and services within and outside a country
without government regulations. Free trade opposes government restrictions
which hinder free trade. Examples of common government restrictions are:
taxes, subsidies, tariffs etc.
Adam Smith, the father of modern economics, became the worlds first
economist to propound the concept of free trade. Other eminent economists
joined ranks with Smith and they were John Maynard Keynes and David
Ricardo. In 1947, the formation of General Agreement on Tariffs and Trade
(GATT) marked a significant step to boost global trade but its role was
taken over by the World Trade Organization (WTO) in 1995.
Promoting free trade between countries is what WTO works to
accomplish. Some of its main functions are to:

Review operation and administration of trade agreements.

Review trade policies of different nations to establish transparency

and uniformity.

Serve as a platform to negotiate and settle disputes between trading

nations.

Provide trade assistance to developing and under-developed

countries, through technical training.

Conduct periodical assessments of global trade.

Research and publish annual reports on world trade.

In addition, the WTO works with the World Bank and the IMF to
ensure greater efficiency. Signing a free trade agreement is the first step
towards facilitating and strengthening free trade. Typically, two countries
sign the agreement. Trade agreements between two or more countries
involve reaching an understanding on tax, tariff and restrictions applicable
on the export and import of goods and services. These treaties, which also
include investment guarantees, typically aim to establish a free trade area,
where goods and services can be exchanged across territorial boundaries
without imposing tariffs. The countries (regions) forming a free trade area
impose a common tariff on goods and services sold to non-member
countries. Specific regions of the world have also made a collective attempt
to create free trade areas for their economic growth. Examples include the
African Free Trade Zone (AFTZ) and the European Economic Area (EEA).
Trade agreements are critical in easing trade between two regions or
countries. The implementation of trade agreements can reduce barriers to
trade and eliminate several prohibitions, which are typically created to
ensure national economic growth and security. Trade agreements typically
include:

Most-Favored-Nation (MFN) Clause: By adding this clause in a

trade agreement, a country awards another country the privilege of
paying the lowest tariffs. All members of the World Trade
Organization (WTO) are required to award the MFN status to each
other.

National Treatment of Non-Tariff Restrictions Clause: Most nontariff restrictions can be crafted to include the properties of tariff in
them. Thus, by adding this clause, countries signing a trade
agreement agree to offer the same treatment that is provided to
domestic good producers.

Reciprocity Feature: By adding this feature, countries in a trade

agreement agree to provide mutual concessions in tariffs and other
commercial restrictions. These concessions agreed upon by both

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1.4.2 Free Trade

the countries are exclusive and do not necessarily apply to other

countries with which they have a commercial treaty.
There are various reasons to advocate free trade. Some of them are as
follows:

Many governments and bureaucratic agencies of different

countries act as trade negotiators. They impose heavy taxes and
tariffs to increase their profitability.

A collective global movement towards free trade can propel great economic
prosperity and global cooperation for trading nations.

Economic Reasons:
1.5 Restrictions on International Trade

Economists with classic views propound free trade for economic

growth.
Their view is that free trade increases the level of output in the
world economy by promoting specialization.
Free trade also lowers prices in an economy by encouraging
competition.

Moral Reasons:

This is the libertarian view pertaining to some intellectuals

belonging to the 18th and 19th century.
Their view is based on moral grounds as they believe trade
restrictions are immoral.

Trade barriers also restrict consumer rights.

Free trade between nations reduces vulnerability to wars.

There are many formal restriction of international trade, which

determines access to the market. The restrictions on international trade are
imposed by the government. In addition to the formal restrictions, there are
informal restrictions also. However, the informal restrictions of trade are not
defined. The informal restrictions lie outside the purview of WTO, although
some of the barriers may be encouraged by the government unofficially.
Non-tariff barriers may include norms, which govern technical
standards and health standards, influencing costs. The non tariff restrictions
are difficult to ascertain, hence they are more frequently treated
quantitatively and are of wide range. Some of the non tariff barriers of
international trade may include the following:

Specific restrictions on international trade: These restrictions

are specifically imposed upon certain goods and services. They
may be in the form of constraints on export, health regulations,
sanitary regulations, embargoes, licensing, minimum price
regulations.

Import charges: These charges are imposed in order to discourage

imports and thereby reduce international trade. They may be of the
following types: internal taxes, tariffs, variable levies, special
import duties etc.

Intervention of the government: Sometimes, the government

may intervene in the trade of goods and services done by their
residents. The government may impose certain extra levies or

However, there are certain limitations of free trade due to which

restrictions may have to be imposed. These include:

The WTO is criticized for favoring large corporations.

Protectionism is apparent in some form or the other. Modern free
trade policies are not entirely free from barriers.

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Standards: The government may prescribe certain standards in the

form of packing, industry standards, labeling regulations and
market regulations in order to place restrictions on free trade.

Procedures followed in administrative and customs entry: The

government may intervene in the procedure of custom clearance of
goods so as to make them lengthy and cumbersome. This is done
with a view to lower trade between countries. The government
may alter the procedure for duties imposed for anti dumping,
customs valuation, customs classification, sample requirements.

Restrictions on international trade with respect to the

environment: Maintaining the ecological balance has become
very important. There are many factors, which hamper the
ecological equilibrium. Many policies have been implemented to
check the same. The restriction of international trade pertaining to
environmental factors include the following:

1. Pollution as a result of processing plants

2. Usage of polluting elements in production procedures
3. Waste disposal

Risks in international trade may be of four categories. These are

discussed below:
1.7.1 Commercial Risks

Risk of insolvency of the buyer: International trade, as

discussed above, envisages trade across borders. This indicates that the
buyer and seller will be located in two different countries in order for
the trade to be international. In such situation, the seller always runs the
risk of insolvency of the buyer in his country, thereby leaving the seller
without payment. Due to long distances and cultural barriers, it may not
always be possible to confirm the financial position of the buyer with
utmost certainty. Every seller, of course, would conduct due diligence in
order to ascertain the liquidity and solvency of the buyer. Further,
insolvency of the buyer may require the seller to recover from the
buyers estate under insolvency procedure as per the laws of the buyers
country. This may not always be beneficial to the seller.

Risk of protracted default: is the failure of the buyer to

pay the amount due within six months after the due date. A grace period
of six months is generally allowed to the buyer in order to fulfill his
obligation under the contract. However, if the buyer fails to do so, the
seller may legally proceed against the buyer to recover his price under
the agreement. This would lead to further litigation and costs to the
seller, which may not be recoverable if the buyer turns insolvent.

Risk of non-acceptance: In cases where delivery is to be

made to the buyers country, the seller runs the risk of non-acceptance
of the goods by the buyer. This entails further cost of collection of
goods from the buyers place and selling them to other customers.

4. How much energy is utilized by processing plants

5. Judicious consumption of energy
Risks in International Trade

1.7.2 Economic Risks

Surrendering economic sovereignty: Economic sovereignty is

the power or national governments to make decisions independently of
those made by other governments. Change in economic and financial
conditions of the partys country, leading to surrender of its

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duties in order to bring the cost of locally manufactured goods at

par with the imported goods. These may be: government
procurement, countervailing duties, subsidies in export, trading of
stocks etc.

Risk of exchange rate: It is a known fact that currency exchange

rates fluctuate with every minute of the day. Given the fact that
international trade is trade across two different countries, it indicates
that the currency at which goods will be traded would be the currency
as agreed between the parties, i.e. either in the currency of the buyer or
the seller. In other situations, parties may agree upon a neutral currency
which this implies that the party that trades in foreign currency runs the
risk of fluctuating exchange rates. For instance, a belonging to the U.S.
agrees to sell 1000 tons of apples to B, who stays in Malaysia. The
contract is entered on January 1, 2008 and delivery is expected to be
made on January 28, 2008, on which day B would pay the amount for
the apples in U.S. dollar. If the U.S. dollar rate in comparison to
Malaysian Ringgit increases on January 28, 2008, B has to pay more
Ringgit in order to buy the same amount of apples. However, if the
price of U.S. dollar drops, B could pay less than what he would be
required to pay on January 1, 2008.
In order to guard against such fluctuating exchange rates
which insert a high level of uncertainty in international trade, the parties
generally agree upon a fixed exchange rate at which goods will be
traded on a future date, irrespective of the market date. However, this
also imposes the burden of risk on one of the parties. In the above
example, if A and B agreed to an exchange rate of 4.5 Ringgit for one
dollar, then A would have to sell the apples on January 28, 2008 for RM
4.5 for one dollar irrespective of the market rate. Thus if the market
exchange rate of dollar is RM 4.9, A is bound to lose because in the
event that the exchange rate was not fixed, A would get a higher price
for his apples. Thus, in both fixed and fluctuating exchange rate
agreements, the parties run the risk of exchange rate.

Susceptibility to changing standards & regulations within

other countries: The governments of every country are empowered to
change the standards, rules and regulations regarding general trading of
goods within their countries. For instance, amendments to the Weights
and Measures Act, Competition Act etc. may directly affect the contract
entered into for international trade. Thus, one of the parties may be
required to provide goods of higher standard due to these changing
standards. This may lead to further cost for which he may not be
adequately compensated.

1.7.3 Political Risks

Risk of cancellation or non-renewal of export or

import licenses: Export and import are crucial limbs of trade between
countries. However, every business man has to comply with certain
regulations in order to obtain licenses or permits to import and export
goods and services. The government may amend these standards,
thereby requiring importers and exporters to re-apply for licenses. In
some situations, the licenses may be cancelled if the import or
exporter falls short of the standards prescribed by the legislations. In
certain other cases, the licenses once granted may need to be renewed
and renewal is granted only upon compliance with the required
standards. Thus the other party in the contract may suffer a loss on
account of cancellation or non-renewal of one partys license to import
or export.

War risks: One of the basic principles of contracts is that

a person cannot enter into a contract or trade with an enemy alien i.e.
the resident of a country who is in war with his own country. Thus,
contracts entered into before war breaks out between two countries
automatically become void on breaking out of war. Parties run the risk
of this, and if contracts do become void, would have to incur huge
losses due to non-fulfillment of the contract.

Risk of expropriation or confiscation of the importer's

company: Most countries have their own laws for nationalization and

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governments decision-making authority, can cause grave problem to

the other party. Such change of conditions may directly affect the
contract between the parties, making it null and void. In other
situations, it may increase the burden on one party, thereby making the
terms unacceptable to one party.

taxing system and rates in both countries in order to see whether the
agreement is at all beneficial or not.

Surrendering
political
sovereignty:
Political
sovereignty is the exclusive right of the sovereign to exercise control
over its territory. However, in grave situations, a country may lose its
political sovereignty if it conquered by another nation or if it
surrenders its sovereignty since it cannot manage its own population.
In such situations, contracts entered into before surrender of
sovereignty may be adversely affected. However, every party has to
take the risk of giving up sovereignty in international trade.

Influence of political parties in importer's company:

Political pressure goes a long way in influencing a companys business
decisions, as is seen even in India. Political parties exert pressure on
corporate houses in order to cater to their own needs. They may also
affect the importers past contracts thereby adversely affecting the
interests of the seller. Political parties and their influence stand as
strong barriers to trade. Generally, persons are reluctant to do business
with residents of countries with strong political parties in order to
avoid such risks.

Relations with other countries: A countrys relations

with other countries highly affect international trade. For instance,
trade between countries with good relations is always smooth.
Residents trading between countries with good relations also may get
incentives and other factors to facilitate trade. However, trade between
two countries may also be affected by relations with other countries.
For example, when the U.S. supports India in a war against Pakistan,
trade between the U.S. and Pakistan may also not be as smooth as it
would in other situations. Thus trade between the U.S. and Pakistan
may be affected by Indo-U.S. relations.
1.7.4 Other Risks

Cultural differences e.g., some cultures consider the payment of an

incentive to help trading is absolutely lawful

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confiscation of companies within their territories. Buyers and sellers in

different countries always run the risk of their or the other partys
company being nationalized or confiscated due to breach of any law.
In the event that one of the parties does lose its company, the other
party is at a grave loss with huge amounts of cost in litigation and recontracting with another party.

Risk of the imposition of an import ban after the

shipment of the goods: This risk is perhaps the most serious and may
turn into huge losses if proved wronged. In certain countries, trade
restrictions and bans may be imposed on importers, taking into
consideration the economic and social conditions of the country.
Sometimes, restrictions may be imposed on an importer due to his
own misgivings and unscrupulous conduct. These restrictions may be
imposed after the goods have been shipped from the sellers country.
Such a situation would mean large costs for the seller to stop the goods
in transit, or re-collect the goods after delivery. It would also entail
losses to both parties. However, both parties have to run this risk
keeping in mind the possible legislative and government changes.

Foreign currency shortages: Imposition of exchange

controls by the importer's country may result in foreign currency
shortage. In case the agreement between the buyer and seller is for the
sale of goods in a currency which is presently in shortage in the
buyers country, the buyer may be unable to fulfill his obligation under
the contract. The parties may then agree to accept payment in another
currency. However, it may not always be possible to agree at another
currency after performance of the contract. Also, accepting payment in
another currency may be harmful to one party depending on the
exchange rate. In such situations, the seller may also be unwilling to
wait for payment till the currency is in flow once again. Thus, foreign
currency shortage is a big impediment in international trade.

Risk of different tax rates: Every country has its own

tax system. Income from sale in other countries may also be amenable
to tax in the sellers country. Likewise, expenses made by the buyer to
outside countries may not be deductable, and therefore amenable to
tax, in the buyers country. Therefore, parties need to understand the

Lack of knowledge of overseas markets

Sovereign risk - the ability of the government of a country to pay

off its debts

Natural risk due to the various kinds natural catastrophes, which

cannot be controlled

Trade barriers: They are state-imposed restrictions on trading a

particular product or with a specific nation. Some of the most
common forms of trade barriers are tariffs, duties, subsidies,
embargoes and quotas.

Safety: This determinant ensures that only high-quality products

are imported in the country. Public officials can lay down
inspection regulations to ensure that the imported product conform
to the set safety and quality standards.

Language barriers
Inclination to corrupt business associates
Legal protection for breach of contract or non-payment is low
Effects of unpredictable business environment and fluctuating
exchange rates

Trade Policy
Trade policy defines standards, goals, rules and regulations that
pertain to trade relations between countries. These policies are specific to
each country and are formulated by its public officials. Their aim is to boost
the nations international trade. A countrys trade policy includes taxes
imposed on import and export, inspection regulations, and tariffs and
quotas.

3.4.2 Types of Trade Policy

Trade policies can assume varying dimensions and scope depending on
the number of parties involved in the policy. Consider the following types
of trade policies:

National trade policy: Every country formulates this policy to

safeguard the best interest of its trade and citizens. This policy is
always in consonance with the national foreign policy.

Bilateral trade policy: This policy is formed between two nations

to regulate the trade and business relations with each other. The
national trade policies of both the nations and their negotiations
under the trade agreement are considered while formulating
bilateral trade policy.

International trade policy: International economic organizations,

such as Organization for Economic Co-operation and Development
(OECD), World Trade Organization (WTO) and International
Monetary Fund (IMF), define the international trade policy under
their charter. The policies uphold the best interests of both
developed and developing nations. The best example is the Doha
Development Agenda which was formulated by the WTO.

3.4.1 Constituents of Trade Policy

A trade policy generally focuses on the following specifications in
terms of international trade:

Tariffs: Every country has the right to impose taxes on imported

and exported goods. Some nations levy heavy tariffs on imported
goods to protect their local industries. High import taxes inflate the
prices of imported goods in local markets, ensuring that local
products are more sought after.

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As open market economy prevails in most developed countries,

international economic organizations support free trade policies while
developing nations prefer partially-shielded trade practices to protect their
local industries. Todays era of globalization depends on sound trade
policies to reflect market changes, establish free and fair trade practices and
expand the possibilities for booming international trade.