Concept of Foreign Trade

Foreign trade is the exchange of goods across national boundaries. It is an exchange of various specialized commodities and services rendered among the corresponding countries is known as foreign trade. Foreign trade is, in principle, not different from domestic trade as the motivation and the behavior of parties involved in a trade do not change fundamentally depending on whether a trade is across a border or not. The main difference is that international trade or foreign trade is typically more costly than domestic trade. The reason is that a border typically imposes additional costs such as tariffs, time costs due to border delays and costs associated with country differences such as language, the legal system, or a different culture. Foreign trade is all about imports and exports. The backbone of any foreign trade between nations is those products and services which are being traded to some other location outside a particular country’s borders.

Some nations have the advantage of producing certain products at a cost-effective price. Perhaps it is because they have the labor supply or abundant natural resources which make up the raw materials needed. No matter what the reason, the ability of some nations to produce what other nations want is what makes foreign trade work.

Types of Foreign Trade

1. Import: Importing is the purchasing of goods or services made in another country. For example, importing edible oil from Chinese producers to sell in Africa.
2. Export: Exporting is selling domestic-made goods in another country. For example, Hameem Garments exports Readymade Garments (RMG) products to Western Countries.
3. Re-export: When goods are imported from a foreign country and are re-exported to buyers in some other foreign countries, it is called re-export. For example, Firm/ Readymade Garments located at EPZs imports raw materials (Cotton) from Korea and produces Readymade Garments products by Thai cotton and then those products to Canada.

Need/Importance/Advantages of Foreign Trade

The following points explain the need and importance of foreign trade to a nation.

1. Division of Labor and Specialization: Foreign trade leads to the division of labor and specialization at the world level. Some countries have abundant natural resources. They should export raw materials and import finished goods from countries that are advanced in skilled manpower. This gives benefits to all the countries thereby leading to the division of labor and specialization.
2. Optimum Allocation and Utilization of Resources: Due to specialization, unproductive lines can be eliminated and wastage of resources avoided. In other words, resources are canalized for the production of only those goods, which would give the highest returns. Thus there is rational allocation and utilization of resources at the international level due to foreign trade.
3. Equality of Prices: Prices can be stabilized by foreign trade. It helps to keep the demand and supply position stable, which in turn stabilizes the prices, making allowances for transport and other marketing expenses.
4. Availability of Multiple Choices: Foreign trade helps in providing a better choice to the consumers. It helps in making available new varieties to consumers all over the world.
5. Ensures Quality and Standard Goods: Foreign trade is highly competitive. To maintain and increase the demand for goods, the exporting countries have to keep up the quality of goods. Thus quality and standardized goods are produced.
6. Raises Standard of Living of the People: Imports can facilitate the standard of living of the people. This is because people can have a choice of new and better varieties of goods and services. By consuming new and better varieties of goods, people can improve their standard of living.
7. Generate Employment Opportunities: Foreign trade helps in generating employment opportunities by increasing the mobility of labor and resources. It generates direct employment in the import sector and indirect employment in other sectors of the economy. Such as Industry, Service Sector (insurance, banking, transport, communication) etc.
8. Facilitate Economic Development: Imports facilitate the economic development of a nation. This is because, with the import of capital goods and technology, a country can generate growth in all sectors of the economy, agriculture, industry and service sector.
9. Assistance During Natural Calamities: During natural calamities such as earthquakes, floods, famines etc., the affected countries face the problem of shortage of essential goods. Foreign trade enables a country to import food grains and medicines from other countries to help the affected people.
10. Maintains Balance of Payment Position: Every country has to maintain its balance of payment position. Since every country has to import, which results in an outflow of foreign exchange, it also deals in export for the inflow of foreign exchange.
11. Brings Reputation and Helps Earning Goodwill: A country that is involved in exports earns goodwill in the international market. For example, Japan has earned a lot of goodwill in foreign markets due to its exports of quality electronic goods.
12. Promotes World Peace: Foreign trade brings countries closer. It facilitates the transfer of technology and other assistance from developed countries to developing countries. It brings different countries closer due to economic relations arising out of trade agreements. Thus, foreign trade creates a friendly atmosphere for avoiding wars and conflicts. It promotes world peace as such countries try to maintain friendly relations among themselves.

What is BOP ?

Balance of Payment (BOP) is an essential economic indicator of a country. It is a method of monitoring all international transactions at a specific period by country. It shows how much a country is receiving from the rest of the world and how much it is paying to the rest of the world. It is the net difference between credit (Received) transactions and debit (Paid) transactions of a country.  Theoretically, the BOP should be zero, meaning that assets (Credits) and liabilities (Debits) should balance, but in practice, this is rarely the case. Thus, the BOP tells if a country has a deficit or a surplus.

The balance of payments (BOP) is the record of all international financial transactions made by the residents of a country. It could be either favorable or unfavorable for a country. More specifically, there could be positive-negative, or zero levels of the BOP for any country. Positive BOP means the excess of receipts over payments of a country. Negative BOP refers to the situation of total receipts being less than total payments. Similarly, zero BOP means the equal level of receipts and payments of a country which is a rare event. However, the total BOP of the world is zero.

There are three main categories of the BOP: the current account, the capital account and the financial account. The current account is used to mark the inflow and outflow of goods and services into a country. The capital account is where all international capital transfers are recorded. In the financial account, international monetary flows related to investment in a business, real estate, bonds and stocks are documented. The current account should be balanced versus the combined capital and financial accounts, leaving the BOP at zero, but this rarely occurs.

Different BOP Accounts

The BOP is divided into three main categories: the current account, the capital account and the financial account.  All the transactions performed internationally, are classified under any of these categories. The different accounts of the balance of payment have been discussed below:

The Current Account

The current account is used to mark the inflow and outflow of goods and services into a country. Earnings on investments, both public and private, are also put into the current account. Within the current account are credits and debits on the trade of merchandise, which includes goods such as raw materials and manufactured goods that are bought, sold, or given away (Possibly in the form of aid). Services refer to receipts from tourism, transportation (Like the levy that must be paid in Egypt when a ship passes through the Suez Canal), engineering, business service fees (From lawyers or management consulting, for example) and royalties from patents and copyrights.

When combined, goods and services together make up a country’s balance of trade (BOT). The BOT is typically the biggest bulk of a country’s balance of payments as it makes up total imports and exports. If a country has a balance of trade deficit, it imports more than it exports and if it has a balance of trade surplus, it exports more than it imports. Receipts from income-generating assets such as stocks (in the form of dividends) are also recorded in the current account. The last component of the current account is unilateral transfers. These are credits that are mostly worker’s remittances, which are salaries sent back into the home country of a national working abroad, as well as foreign aid that is directly received.

The Capital Account

The capital account is where all international capital transfers are recorded. This refers to the acquisition or disposal of non-financial assets (For example, a physical asset such as land) and non-produced assets, which are needed for production but have not been produced, like a mine used for the extraction of diamonds. The capital account is broken down into the monetary flows branching from debt forgiveness, the transfer of goods and financial assets by migrants leaving or entering a country, the transfer of ownership on fixed assets (Assets such as equipment used in the production process to generate income), the transfer of funds received to the sale or acquisition of fixed assets, gift and inheritance taxes, death levies and, finally, uninsured damage to fixed assets.

The Financial Account

In the financial account, international monetary flows related to investment in a business, real estate, bonds and stocks are documented. Also included are government-owned assets, such as foreign reserves, gold, special drawing rights (SDRs) held with the International Monetary Fund (IMF), private assets held abroad and direct foreign investment. Assets owned by foreigners, private and official, are also recorded in the financial account.