Global Business Environment
Economic environment:
trade issues
Readings
–
World Trade Report 2009. Executive Summary.
http://www.wto.org
–
GYÖRGY MIKÓSDI: The Financial Crisis and
International Trade. Development and Finance
2009/2. www.ffdf.mfb.hu
–
GÁBOR OBLATH - LILLA JUTKUSZ: Terms of
Hungarian Foreign Trade in the Long Run and in
the 1990s.. Development and Finance 2003/3.
www.ffdf.mfb.hu
Economic environment
1.
2.
3.
4.
5.
6.
The changing nature of international business/trade
in historical perspective, Changing world output and
world trade; International institutions;
International monetary environment, financial flows,
Foreign Direct Investment (FDI) trends;
Business cycles;
Development and competitiveness indicators;
Economic integration;
Global problems;
 Economic Risk
Economic environment - Trade
1.
2.
3.
Close linkages through trade in goods and
services, through flows of money, and through
investment than ever before liberalisation and
globalisation.
When a buyer and a seller engage in a voluntary
transaction, both receive something that they want
and both can be made better off.
Trade is predicted to benefit a country by making it
more efficient when it exports goods which use
abundant resources and imports goods which use
scarce resources.
Economic environment - Trade
4.
When countries specialize, they may also
be more efficient due to large scale
production.
5.
Countries may also gain by trading current
resources for future resources (lending
and borrowing).
Economic environment - Trade
6.
Trade is predicted to benefit countries as a whole in
several ways, but trade may harm particular groups
within a country.
–
International trade can adversely affect the owners of
resources that are used intensively in industries that
compete with imports.
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Trade may therefore have effects on the distribution
of income within a country.
–
Conflicts about trade should occur between groups
within countries rather than between countries.
–
But less developed countries generally loose in free
trade!
Economic environment - Trade
7.
Explanations of trade
–
Differences in climate and resources can
explain why Brazil exports coffee and Australia
exports iron ore.
–
Differences in labour productivity may explain
why some countries export certain products.
–
How relative supplies of capital, labour and
land are used in the production of different goods
may also explain why some countries export
certain products
Economic environment - Trade
Economic theory on free trade versus
protectionism
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Mercantilist:
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importing leads to a decrease of national welfare;
Importing will lead to an outflow of gold/money;
Trade is a zero-sum game: One country wins, the other
one loses;
Because of this, countries should try to minimise imports
and maximise exports as much as possible;
The objective is to achieve trade surplus = exportoriented economic strategy.
Economic environment - Trade
Classical economics: Adam Smith’s
“theory” of absolute advantage.
–
 If
the Netherlands can produce beer
better/cheaper and Spain is better in wine,
the Netherlands should specialise in beer
and Spain in wine;
 The total production of beer and wine will
increase and will lead to a win-win situation.
Economic environment - Trade
–
David Ricardo: theory of comparative
advantages
 Even
in a situation in which country A is more
efficient (cheaper) in all products compared
with country B both countries will benefit
(increase their welfare).
 A country’s production pattern is determined
by comparative advantage.
Economic environment - Trade
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Factor-Proportions theory: A country with a lot
of supply (=cheap) of labour will concentrate on
labour intensive production, a country with
relatively more capital will specialise in capital
intensive products.
Economies of scale (i.e. lower unit costs with
larger output) give countries an incentive to
specialize and trade even in the absence of
differences between countries in their resources
or technology.
Economic environment - Trade
Free trade versus protectionism
Arguments for free trade:
1.
2.
3.
Efficiency
Additional gains (economies of scale, competition)
Costs of distorting trade
Historical fact: the world’s three largest market
economies all began their industrialisation behind trade
barriers.
Economic environment - Trade
Argument against free trade
1.
Infant industry argument
A country may have a potential comparative advantage in
manufacturing, but new manufacturing industries cannot
initially compete with well established manufacturing in
more developed countries
2. National defence argument
Country must be self-sufficient in critical raw materials,
machinery, and technology or else be vulnerable to foreign
threats.
3. Maintenance of Existing Jobs
Jobs in high-wage countries threatened by imports from
low-wage countries
Economic environment - Trade
National trade policies: The role of domestic politics
in formulating a country’s international trade policies.
Issues:
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Should a national government intervene to protect the
country’s domestic firms by taxing foreign goods entering
the domestic market or constructing other barriers against
imports?
Should a national government directly help the country’s
domestic firms increase their foreign sales through export
subsidies, government-to-government negotiations, and
guaranteed loan programs?
Different approaches of developed and developing states to
the international legal framework governing international
trade.
Economic environment - Trade
National Trade Policies: Export based and import
substitution strategies: When industrial policy is
pursued, the national government:
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identifies key domestic industries critical to the
country’s future economic growth and
then formulates programs that promote their
competitiveness.
Special interest groups are lobbying for special
subsidies or tariffs and other forms of protection
Import-substituting industrialisation
From World War II until the 1970’s many
developing countries attempted to accelerate
their development by limiting imports of
manufactured goods in order to foster a
manufacturing sector serving the domestic
market. This strategy is known as the strategy
of import-substituting industrialisation.
Problems of ISI
1. A period of protection will not create competitive
manufacturing sector if there are fundamental
reasons why a country lacks a competitive
advantage in manufacturing. (lack of skilled labor,
entrepreneurs, managerial competence, etc.) These
problems cannot be solved by trade policy.
2. It promoted production at an inefficiently small scale.
Economic environment - Trade
After World War II. trade liberalisation
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International negotiations;
International trade agreements (General Agreement on
Tariffs and Trade (GATT));
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Most-favoured-nation treatment requiring countries not to
discriminate between goods on the basis of their origin or
destination;
National treatment principle: Imported and locally-produced
goods should be treated equally - at least after the foreign
goods have entered the market.
Reciprocity – limit free-riding
Binding and enforceable commitments
Transparency – notification
Safety valves (restrict trade: non-economic, economic, fair
competition
Economic environment - Trade
The GATT embodies a set of rules of conduct
for international trade policy. Prohibitions:
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•
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Export subsidies (except agriculture)
Import quotas (except „market disruptions”)
Tariffs (any new tariff or increase in a tariff
must be offset by reductions in other tariffs to
compensate the affected exporting countries9.
International negotiations
and trade policy
Preferential Trading Agreements
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Nations establish preferential trading
agreements under which they lower tariffs with
respect to each other but not the rest of the world.
The GATT-WTO, through the principle of nondiscrimination called the “most favored nation”
(MFN) principle, prohibits such agreements.

The formation of preferential trading agreements is
allowed if they lead to free trade between the agreeing
countries.
Levels of regional integrations
1.
2.
3.
4.
5.
6.
7.
Preferential trade agreements
Free trade agreement
Customs union
Common market (free movement of good, services,
labour, capital)
Single market
Economic union (Fiscal, monetary union)
Political union
International negotiations
and trade policy
–
Free trade can be established among several WTO
members as follows:

A free trade area allows free-trade among members, but
each member can have its own trade policy towards nonmember countries.
–
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A customs union allows free trade among members and
requires a common external trade policy towards nonmember countries.
–
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Example: The North American Free Trade Agreement
(NAFTA) creates a free trade area.
Example: The European Union (EU) is a full customs union.
A common market is a customs union with free factor
movements (especially labor) among members.
International negotiations
and trade policy

Are preferential trading agreements good?
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It depends on whether it leads to trade creation or
trade diversion.
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Trade creation
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Occurs when the formation of a preferential trading
agreement leads to replacement of high-cost domestic
production by low-cost imports from other members.
Trade diversion
–
Occurs when the formation of a preferential trading
agreement leads to the replacement of low-cost imports
from non members with higher-cost imports from member
nations.
Indicators of international trade I.
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Export ratio;
Import ratio;
Openness to trade;
Openness to world economy;
Commodity pattern (structure) of trade;
Geographical pattern of trade;
Terms of trade is the relative prices of a
country's export to import
Economic environment - Trade
Some facts on development of trade
1. Size Matters: The Gravity Model
In fact, the size of an economy is directly
related to the volume of imports and exports.
–
Larger economies produce more goods and
services, so they have more to sell in the export
market.
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Larger economies generate more income from
the goods and services sold, so people are able
to buy more imports.
Economic environment - Trade
Other things besides size matter for trade:
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Distance between markets influences
transportation costs and therefore the cost of
imports and exports.
Distance may also influence personal contact
and communication, which may influence trade.
Cultural affinity: if two countries have cultural
ties, it is likely that they also have strong
economic ties.
Geography: ocean harbors and a lack of
mountain barriers make transportation and trade
easier.
Economic environment - Trade
2. Multinational corporations: corporations spread
across different nations import and export many
goods between their divisions.
3. Borders: crossing borders involves formalities that
take time and perhaps monetary costs like tariffs.
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These implicit and explicit costs reduce trade.
The existence of borders may also indicate the existence
of different languages or different currencies, either of
which may impede trade more.
Borders increase the cost and time needed to trade.
Economic environment - Trade
4. Trade agreements: between countries are
intended to reduce the formalities and tariffs
needed to cross borders, and therefore to
increase trade.
5. Estimates of the effect of distance from the
gravity model predict that a 1% increase in
the distance between countries is associated
with a decrease in the volume of trade of
0.7% to 1%.
Economic environment - Trade
6. Has the World Become “Smaller”?
–
The negative effect of distance on trade according
to the gravity models is significant, but it has
grown smaller over time due to modern
transportation and communication.
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But history has shown that political factors, such
as wars, can change trade patterns much more
than innovations in transportation and
communication.
Economic environment - Trade
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There were two waves of globalization.
1840–1914: economies relied on steam power,
railroads, telegraph, telephones. Globalization was
interrupted and reversed by wars and depression.
 1945–present: economies rely on telephones,
airplanes, computers, internet, fiber optics,…

Economic environment - Trade
7. Changing Composition of Trade
What kinds of products do nations currently trade,
and how does this composition compare to trade in the past?
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Today, most of the volume of trade is in manufactured
products such as automobiles, computers, clothing and
machinery.
–
Services such as shipping, insurance, legal fees and
spending by tourists account for 20% of the volume of
trade.
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Mineral products (e.g., petroleum, coal, copper) and
agricultural products are a relatively small part of trade.
–
In the past, a large fraction of the volume of trade came
from agricultural and mineral products.
Economic environment - Trade
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Developing countries, or low and middle-income
countries, have also changed the composition of
their trade.
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In 2008, about 65% of exports from developing
countries were manufactured products, and only
10% of exports were agricultural products.
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In 1960, about 58% of exports from developing
countries were agricultural products and only
12% of exports were manufactured products.
Economic environment - Trade
• World gross
domestic product
(GDP) and world
merchandise exports
not only move in
tandem, but export
growth exceeds GDP
growth.
• Growth of world
GDP is associated
with an even higher
growth in nternational
trade.
• Declines also show
the same tendency