We live in a global economy where the rate of transfer of information and goods and services is nothing like we’ve ever experienced in human history. The vast majority of businesses have some aspect of their supply chain that touches outside of their domestic economy. Although the pandemic is forcing businesses to think differently in terms of having more of their supply chains situated domestically, competition will continue to force companies to search for cost efficiencies and improvements in net margins of their business streams.
Similarly, all national governments have some involvement in international trade. To sustain economic growth and the growth of their nation, governments seek trade with their neighbors and the rest of the world to export surplus goods produced domestically, as well as to import goods and services in which do not exist domestically, or can be purchased internationally for cheaper compared to producing the same good or service domestically. According to the World Bank WTIS data, in 2018, total global exports equaled roughly $20.8 trillion USD, and total global imports equaled roughly $18.9 trillion USD, resulting in a roughly $1.96 trillion USD trade surplus.
Being able to export high priced goods and import lower priced goods increases the economic welfare of a nation. International trade, again similarly to businesses, induces global competition amongst producers which lowers prices and allows for more efficient allocation of resources within each country.
Governments alone cannot effectively promote and protect economic development domestically, and therefore trading blocs are established amongst countries to help with such economic promotion and development. A trading bloc comprises of a group of countries that agree to work together in order to protect themselves against rising prices of imports and trade competition from non member countries. Trading blocs allow free trade amongst member nations and can have many or little trade restrictions. Trading blocs allow sharing of resources and expertise amongst member nations to expand into new trading markets, promote economies of scale within the bloc, improve domestic production efficiency, create jobs, and reduce the risk of competition from non member countries.
When it comes to international trade, it is a complex system that governments alone cannot manage. There are various institutions that facilitate international trade, along with federal governments. The three key organizations are the International Monetary Fund (IMF), World Trade Organization (WTO), and the World Bank Group (WBG). Each of these organizations serve different purposes when it comes to trade and global currencies, but together they provide stability to international monetary systems and facilitate international trade and economic development.
International Monetary Fund
The primary purpose of the IMF is to maintain stability of the international monetary system itself, global exchange rates, and transfer of international payments to ensure smooth transaction of goods and services between countries. This helps manage both domestic and global systemic risk and market risks. The IMF is also in charge of lending foreign currencies during an economic crisis that may be impacting foreign exchange rates to a country’s domestic currency. This lending is meant to ensure exchange rate and economic stability. IMF has their own database of international financial statistics including global exchange rates, GDP, and CPI.
World Trade Organization
The WTO is responsible for coordinating trade agreements between countries around the world, ensuring transparency of trading policies within such agreements, and acting as an intermediary between countries when trading disputes arise. The WTO sets regulatory frameworks of global trade rules to allow efficient free trade amongst nations that, arguably, play a large part in how today’s global multinational companies do business with one another. WTO provides a database on international trade statistics that is updated every quarter.
World Bank
The World Bank helps to create the basic economic infrastructure essential for creation and maintenance of domestic financial markets and a working financial industry in developing countries. The WBO helps provide capital and the necessary funding for various projects in development countries that may have difficulty in accessing global credit markets because of low credit ratings (due to government corruption, economic turmoil, etc.). In other words, the WBO ensures that financial markets are properly functioning in these developing countries by aiding in the creation of a standard economic infrastructure for efficient financial markets. As referenced earlier, the World Bank has a database of international trade statistics.
Although the exchange of goods and services between nations drives economic activity for all parties involved, too much international competition can actually hurt domestic employment and increase income inequality. For example, an increase in imports can cause domestic producers to compete with the same foreign companies in which the exported goods came from in the first place.
There are two ways in which governments can protect domestic producers and markets, either via trade restrictions, or capital restrictions. Trade restrictions affect goods and services directly that are imported and exported to protect domestic producers, whereas capital restrictions affect financial assets, or actual capital, that flows between two countries to protect domestic markets.
Governments can impose trade or capital restrictions to do the following:
1) Discourage acquisition of domestic producers by foreign companies
If one country’s exports are the sole input into a production process of a foreign company’s good or service, the foreign entity may find it advantageous to simply purchase the domestic producer to own that part of the supply chain in house.
2) Restrict capital inflow from exports
As exports increase, this results in more capital inflow to the country, which could actually drive up domestic competition amongst local producers.
3) Manage trade depending on business cycle
Depending on whether a country’s economy is experiencing a recession or growth, governments may want to manage the capital inflows and outflows due to trade. During recessions, governments may want to encourage domestic spending and capital inflows, and therefore encourage exports to move towards a future trade surplus. The opposite can be said during economic growth where a government may want to encourage capital outflows and increase imports. In other words, capital restrictions can help manage flow to smoothen the overall business cycle.
4) Manage trade surplus/deficit levels
Similar to the point above, capital restrictions on trade may be imposed to create equilibrium in the domestic savings market, ensuring that savings rates start going up near peak business cycle, and savings rates begin declining near the trough of business cycles to encourage spending and spurring of domestic economic activity.
Examples of trade restrictions include:
Tariffs - taxes imposed on imported goods
License – limits the ability to import specific goods
Import quotas – a target/restriction for an amount of a specific good to be imported
Voluntary export restraint - a cap on exports established by an exporting nation
Local content requirements - a mandate to use goods and services produced domestically
Examples of capital restrictions include:
Restrictions on foreign investments in a specific country(ies) or industry(ies)
Taxing foreign investment income
Restrictions on repatriation of earnings of foreign entities or income from foreign investment
International trade is a complex system with ample moving parts, and this article aims at providing a high-level summary of how this system operates, the motivations behind why nations regulate trade, and the organizations that help facilitate this regulation. It’s very rare that any business or nation can behave autarkically (national economic self sufficiency and independence), simply due to the global nature of national economies and because of the detriment to a business or nation’s survival that a closed off economy would pose domestically. The beneficiaries of efficient and regulated international trade are every trading partner involved, and the faster that money cycles through these economies, the more sustainable global economic growth can be, especially for developing nations.