Improving trade relations for economic growth

International economic issues have taken centre stage in recent years. Several global conventions take place to address issues related to trade and policies. Nations have become more interdependent than ever.

 Though the growth in international trade and investment has been there for a long time, in recent years the interdependence has grown significantly. With the exponential advancement of international trade and the intertwining of the countries across the globe, there have been episodes of trade conflict and these have become increasingly evident and also interesting from the point of view of analysis.

One such conflict is to worry and understand gains from trade. Some policies, movements, and withdrawals have led to less than desirable situations for countries. A prime example is Brexit. The introduction of post-Brexit trading rules has led to a major shock to the UK-EU trade. The party at a greater loss in the Brexit situation is the UK.

One popular perception is that if one country gains through trade then the other country would be losing but contrary to the popular belief, there can be a wide range of circumstances in which all countries can mutually gain from trade and there could be circumstances in which international trade is a positive-sum game, not a zero-sum game.

Pareto efficiency is a situation where “no further improvements to society's well-being can be made through a reallocation of resources that makes at least one person better off without making someone else worse off.” Even if international trade ensures some positive gains for both the countries involved in trade, it may not ensure a Pareto superior situation for all concerned. In other words, the gains from trade can be unevenly distributed. Judging the gains from international trade can be very subjective depending on which perspective we are talking about.

European Union

Are we talking about the gains for the individual nations or are we talking about gains in general for the community of nations? The world news is currently being dominated by headlines about Ukraine’s desperate attempt to join the European Union. Ukraine is a very resourceful state. By the same token, the EU has managed to benefit certain member nations greatly as opposed to some poorer nations despite forming an economic union.

There are four basic questions in international trade; what is the importance of international trade? Why do nations import and export certain products? What is the basis of trade? What are the terms of trade at which products in the international arena are exchanged in the community of nations? What are the gains from trade in terms of production and consumption?

From the very inception of trade theory, the idea was based on the possible existence of gains from trade. One of the oldest theories in this field is that of Mercantilism. The term was coined by Marquis de Mirabeau. Mercantilism is an economic theory where the government seeks to regulate the economy and trade to promote domestic industry, mostly at the expense of other countries. Mercantilism is associated with policies that restrict imports, increase stocks of gold and protect domestic industries.

From 1500 to 1880, according to the mercantilist, if a country could achieve a favourable trade balance, it would realize a net payment receivable from the rest of the world and this would be in the form of gold and silver and this would contribute to the nation-building process. But the mercantilists were of the view that international trade is based on the idea of the fixed wealth of nations, that is that one nation's gain from trade came at the expense of its trading partner, and not all nations could simultaneously enjoy the benefits of trade.

This view was first challenged by the classical economist Adam Smith and later other proponents also challenged this view. Some modern trade theorists suggested that both the trading partners could simultaneously enjoy a higher level of production and consumption along with trade. Ricardo’s theorem of comparative advantage suggested that specialisation in trade could lead to gains from trade for both the nations involved in the trade.

Like Adam Smith, Ricardo also emphasized the supply side of the market, however, unlike Adam Smith, Ricardo emphasised the comparative cost differences and asserted that both nations could gain from trade. The sources of gains from trade are many: differences in cost ratios, the possibility of reciprocal demand as we have noticed between trading blocs, terms of trade, productive efficiency, nature of commodities exported, and size of the country. The gains from international trade depend on differences in competitive cost ratios in the two trading nations.

A country gains by foreign trade if and when the traders find that there exists a ratio of prices very different from home. Any acceptable international terms of trade have to be more favourable than or equal to the rate defined by the domestic price line. The reason for mutually beneficial trade is thus bounded by the cost ratios of the two nations. The greater the differences in competitive cross ratios, the larger the gains from trade.

Where reciprocal demand is concerned, the actual terms of trade are determined by the relative strength of each country's demand for the other country's product. A country gains most from trade whose demand for foreign goods is highly elastic while the other country's demand for its goods is highly inelastic. Kenya has a strong presence in the international tea and horticulture market. Another important factor that determines the gains from trade is the terms of trade.

International exchange ratio

The commodity terms of trade is a frequently used measure of the international exchange ratio. It measures the relationship between the prices a nation gets for its exports and the prices it pays for its imports. An increase in the productive efficiency of a country also determines its gains from trade as it lowers the cost of production and prices of goods that a country exports. A country that exports mainly primary products has unfavourable terms of trade consequently its gains will be smaller.

On the contrary, a country exporting manufactured goods has favourable terms of trade and its gains from trade will be larger. If two nations are of unequal economic size it is possible that if a trade comparison is drawn, the relative trade of the smaller nation will be dwarfed by that of the larger nation.

Assuming the absence of monopoly elements working in the markets, the small nation can export as much of the commodity as desired, enjoying larger gains from trade. If one nation is significantly larger than another, the larger nation attains fewer gains from trade while the small nation attains most of the gains from trade.

The situation is characterised as the importance of being unimportant. The expansion of choice means that it is always possible to redistribute income in such a way that everyone gains from trade. In reality, the economy consists of heterogeneous groups of people. So the government must weigh one group’s gains against another group’s losses. 

There are many reasons like political pressure, well-organized groups already in power, very poor groups, and particular groups who get special attention and treatment more than others.

Ritesh Barot, is a business and financial analyst, humanitarian, conservationist, occasional artist, and recipient of OGW honor.  Email: [email protected]