Foreign Trade

What is now called international trade has existed for thousands of years long before there were nations with specific boundaries. Foreign trade means the exchange of goods and services between nations, but speaking in strictly economic terms, international trade today is not between nations. It is between producers and consumers or between producers in different parts of the globe. Nations do not trade, only economic units such as agricultural, industrial, and service enterprises can participate in trade.

Goods can be defined as finished products, as intermediate goods used in producing other goods, or as agricultural products and foodstuffs. International trade enables a nation to specialize in those goods it can produce most cheaply and efficiently and it is one of the greatest advantages of trade. On the other hand, trade also enables a country to consume more than it can produce if it depends only on its own resources. Finally, trade expands the potential market for the goods of a particular economy. Trade has always been the major force behind the economic relations among nations. Different aspects of international trade and its role in the domestic economy are known to have been developed by many famous economists. International trade began to assume¹ its present form with the establishment of nation-states in the 17th and 18th centuries, new theories of economics, in particular of international trade, having appeared during this period.

In 1776 the Scottish economist Adam Smith, in The Wealth of Nations, proposed that specialization in production leads to increased output and in order to meet a constantly growing demand for goods it is necessary that a country's scarce resources be allocated efficiently. According to Smith's theory, it is essential that a country trading internationally should specialize in those goods in which it has an absolute advantage — that is, the ones it can produce more cheaply and efficiently than its trading partners can. Exporting a portion of those goods, the country can in turn² import those that its trading partners produce more cheaply. To prove his theory Adam Smith used the example of Portuguese wine in contrast to English woolens³.

Half a century later, having been modified by the English economist David Ricardo, the theory of international trade is still accepted by most modern economists. In line with the principle of comparative advantage, it is important that a country should gain from trading certain goods even though its trading partners can produce those goods more cheaply. The compara-tive advantage is supposed to be realized if each trading partner has a product that will bring a better price in another country than it will at home. If each country specializes in producing the goods in which it has a comparative advantage, more goods are produced, and the wealth of both the buying and the selling nations increases.

Trade based on comparative advantage still exists: France and Italy are known for their wines, and Switzerland maintains a reputation for fine watches. Alongside this kind of trade, an exchange based on a competitive advantage began late in the 19th century. Several countries in Europe and North America having reached a fairly advanced stage of industrialization, competitive advantage began to play a more important role in trade. With relatively similar economies countries could start competing for customers in each other's home markets. Whereas comparative advantage is based on location, competitive advantage must be earned by product quality and customer acceptance. For example, German manufacturers sell cars in the United States, and American automakers sell cars in Germany, both countries as well as Japanese automakers competing for customers throughout Europe and in Latin America.

Thus, international trade leads to more efficient and increased world production, allows countries to consume a larger and more diverse amount of goods, expands the number of potential markets in which a country can sell its goods. The increased international demand for goods results in greater production and more extensive use of raw materials and labour, which means the growth of domestic employment. Competition from international trade can also force domestic firms to become more efficient through modernization and innovation.

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