30. International trade

International trade merits special attention because it differs in several crucial respects from the exchanges of goods and services that take place within a country. First, there are more obvious “barriers” to trade between countries than to trade within countries. These can be simply the result of differences in economic structure, tradition, language or natural resources, or they can be restrictions imposed by governments on the movement of imports, exports, labour and capital. Secondly, different countries use differ­ent currencies, and trade is only possible where the currency of one country can be exchanged for the currency of another one. This fact alone is of little consequence where the relationship between currencies is fixed, but in practice the relative values of currencies often change, presenting us with a whole series of additional economic problems. Finally, economic conditions and government policies normally vary more significantly between countries than between regions of a country. Thus buoyant demand in the UK might cause the purchase of more goods and services from abroad than foreigners buy from the UK, resulting in balance of payments problems in the UK.

Terms of trade

We have seen that gains from trade are possible when comparative costs differ, and that the size of the overall gain and how it is distributed between countries will depend on the prices at which trade takes place. These prices (the terms of trade) will depend on the demand and supply for products of international trade. The country with the most highly desired goods on offer will receive the most advantageous terms of trade.

We define a country’s terms of trade as the quantity of that country’s exports that have to be sold per unit of imports. The terms are expressed as an index, and they are estimated by comparing the average price of exports with the average price of imports. Thus:

T =px x 100 pm

Where T = terms of trade, px = an index of the average price of exports and pm = an index of the average price of imports.

An ‘improvement’ in the terms of trade means that the country is able to obtain more imports for a given quantity of exports than before. This appears to be a good thing, but a country’s export prices can be driven up either by strong foreign demand or by domestic inflation. The former reason is wholly beneficial and can be regarded as a genuine improvement in that country’s external position. However, if prices are running ahead of other countries’ export prices, the benefits to be gained from the ‘improving’ terms of trade will be short-lived.

Conversely, a ‘deterioration’ in the terms of trade means that a country is able to buy less imports per unit of exports. A deterioration can be organised deliberately by a policy of currency depreciation which lowers the price of exports and raises the price of imports. Exports are therefore encouraged and imports discour­aged sufficiently.

Comprehension:

1. Why does international trade merit special attention?

2. What do the terms of trade depend on?

3. What does “deterioration” in the terms of trade mean?

4. How can we characterize improvement in terms of trade?