INTERNATIONAL TRADE

The basic idea of international trade and investment is simple: each country produces goods and services that can be either consumed at home or exported to other countries. The main difference between domestic trade and international trade is the use of foreign currencies to pay for goods and services crossing international borders. Although global trade is often added up in U.S. dollars, the trading itself involves a lot of currencies.

Trading in goods may be done between countries, states, and individuals for their mutual benefit. If a country has exports in excess of its imports, that country will be magnifying its income. In trade, two fundamental concepts are absolute advantage and comparative advantage.

Absolute advantage is when one nation can produce a product more efficiently than the other. Thus, a basis of trade is created. Comparative advantage allows even a nation that can produce two goods more efficiently to establish a basis for trade. The law of comparative advantage is the fundamental reason for trading. It is when two entities, each one producing the same two types of goods, specialize in one good that it can produce at a lower opportunity cost. Therefore, both entities derive more goods by trading because each entity can offer the best produced goods at the best possible price. Any two entities can engage in trade,

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i.e. two nations, two states, or two persons. Through specialization and free trade, nations can achieve a more efficient allocation of scarce world resources, thereby raising standards of living.

Whenever a country imports or exports goods and services, there is a resulting flow of funds: money returns to the exporting nation, and money flows out of the importing nation. Trade and investment is a two-way street, and with a minimum of trade barriers, international trade and investment usually make everyone better off.

In an interlinked global economy, consumers are given the opportunity to buy the best products at the best prices. By opening up markets, a government allows its citizens to produce and export those things they are best at and to import the rest, choosing from whatever the world has to offer. While free trade has advantages and disadvantages, a nation may elect to restrict trade through tariffs and import quotas, and non-tariff barriers. The economic consequences of import restrictions are almost the same as those resulting from an increase in transportation costs. Such costs raise prices in the importing country and reduce the volume of goods consumed. Such restrictions may be made to protect a new industry, or to protect national security.

Just like any business, a country has to keep track of its inflow and outflow of goods, services, and payments. At the end of any given period, each country has to look at its "bottom line" and add up its international trade in one way or another. The narrowest measure of a country's trade, the merchandise trade balance, looks only at "visible" goods such as videocassette recorders, wine, and oranges.

The current account is a better measure of trade, because it includes a country's exports and imports of services, in addition to its visible trade. It may not be obvious, but many countries make a lot of money exporting "invisibles" such as banking, accounting, and tourism. The current account tells us which countries have been profitable traders, running a current account surplus with money in the bank at the end of the year, and which countries have been unprofitable traders, having imported more than they have exported, running a current account deficit, or spending more than they have earned.

Trade deficits and surpluses are balanced by payment that make up the difference. A country with a current account surplus, for example, can-use the extra money to invest abroad, or it can put it in its cookie jar о foreign currency reserves. A country running a current account deficit has to look abroad for loans or investments, or be forced to dip into its own reserves to pay for its excessive imports. All of these payments and transfers of funds are added up in a country's capital account.

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The widest measure of a country's trade is called its balance of payments. It includes not only payments abroad, but the goods, services, and all transfers of funds that cross international borders. The balance of payments adds up everything in a country's current account and capital account. Since all the trade in goods and services is "balanced" by the international transfers of funds, the balance of payments should add up to zero at the end of the accounting period. Every banana, every automobile, every payment and investment that crosses a country's borders gets included in the balance of payment.

Foreign investment is a result of trade surpluses. When a hardworking country exports more than it imports, it ends up with money to invest in the world markets. This money can be used abroad to buy anything from foreign government bonds to real estate and companies. The United States, for example, has a long history of investing in other countries whenever it runs trade surpluses. However, when the United States began running trade deficits in the 1980s, the billions of dollars spent by Americans on foreign goods, such as videocassette recorders, returned as foreign investments in the U.S. economy. Despite the criticism these investments received, they did help to keep the American economy running on track and created many new jobs for local workers.