Foreign trade

Foreign trade is the exchange of goods and services between two or more countries.

Foreign trade

Foreign trade is the purchase or sale of goods and services that is carried out outside the geographical borders of a country (abroad). That is, the parties interested in trading products are located in different countries or regions.

Foreign trade is generally subject to various regulations for both product control (health, safety, etc.), as well as procedures (bureaucratic procedures, records, etc.) and taxation (taxes, tariffs, etc.).

The main objective of foreign trade is to satisfy consumer demand by taking advantage of the comparative advantages that each country has. The concept that encompasses the foreign trade of all countries is that of international trade. See international trade

It is important to mention that the development of foreign trade occurs thanks to the existence of trade liberalization, in addition to the elimination of prohibitions and tariff barriers. In turn, customs and freight policy, as well as that of foreign trade taxes, must be rational and prudent. It should try to promote competition for the good or service abroad and allow the country to receive other different currencies. All this, in order that it can import goods or services without any type of protectionist policy.

Characteristics of foreign trade

Foreign trade has the following basic characteristics:

  • By definition, it is a trade outside the borders of the country, which can trade with one or more nations.
  • Countries that trade have open economies (they allow transactions with other countries) or at least have foreign trade agreements with a particular country.
  • It is usually subject to special regulations (control, process, taxes, etc.)
  • Countries interested in exchanging goods and services with others usually sign commercial agreements or conventions that seek to facilitate exchange processes.
  • The entry or exit of products will generate a flow of foreign exchange. When countries that trade have different currencies, the value of the currency relative to the local currency is reflected in the exchange rate.
  • Exchange rate fluctuations can affect foreign trade flows between countries that have different currencies.
  • Usually there is a public body in charge of controlling the entry and exit of goods from a country. This body is called Customs and it is in charge of controlling the entry and exit flows of goods across the border and of the application of taxes (rates or tributes) that the law determines.

Advantages and disadvantages of foreign trade

One of the greatest advantages of foreign trade is the possibility that people and companies can access goods and services (including inputs) more varied and cheap. Indeed, foreign trade encourages competition between different countries that have different availability of resources. This allows people to access goods that are not produced locally or the same local goods but at a reduced price.

Foreign trade also makes it possible to complement domestic production when it is insufficient to satisfy local demand.

In addition, foreign trade boosts efficiency as it allows countries to take advantage of their comparative advantages, both in resources and in technology or location.

However, foreign trade can be detrimental to less efficient local businesses. Indeed, the increased competition from companies in other countries may put pressure on the exit of local companies that are not able to adapt and attract customer preferences. However, this is not harmful to consumers or to society in general. In fact, this is the objective of the free market, to promote competition so that only the most efficient can stay and satisfy consumer demand in the best possible way (with lower prices and higher quality).

Foreign trade models

In economics there are various models that attempt to explain the logic of foreign trade flows over a period of time, trying to identify which are the determining factors and how their variation affects trade flows. Here are four of the best known briefly:

  • Absolute Adam Smith Advantage : According to this model, goods will be produced and exported from countries with the lowest absolute costs of production. Thus, for example, if country A has a lower cost of producing shoes than the rest (B, C, … Z), either because its inputs are cheaper or it is capable of using fewer inputs, the shoes will be produced in A and they will be exported to the rest of the countries.
  • Relative advantage of David Ricardo : According to Ricardo’s model, what is relevant to determine what will be produced and traded in a country are not the absolute costs, but the relative costs. In this way, even when a country has an absolute cost disadvantage with all the others, it will still be able to take advantage of the advantages of foreign trade by focusing its production on the goods in which it is relatively more efficient.
  • Heckscher-Ohlin Model : The proposal of this model is that countries will focus their production on goods that are more intensive in the factor of production that is more abundant in the country. Thus, for example, if a country has an abundant labor force, then it will tend to produce labor-intensive goods, while it will import capital-intensive goods.
  • Singer-Prebish model: According to this model, foreign trade generates a real exchange relationship between developed and undeveloped countries that is detrimental to the latter. In effect, the prices of inputs or raw materials in which the poorest countries tend to specialize tend to decline, while the more processed products, typical of developed countries, tend to rise. The authors recommend that undeveloped countries boost their local production and reduce foreign trade.

Forms of foreign trade

The three basic forms of foreign trade are as follows:

  • Export: They are the set of goods and services sold by a country in foreign territory.
  • Import: They are the set of goods and services purchased by a country in foreign territory for use in the national territory.
  • Transit trade : Transit trade is considered to be economic services in which the individual who executes the operation does not have a registered office either in the exporting or importing country, but is located in a third country.

There are also special forms that do not fall into the previous categories:

  1. Direct international investments.
  2. Compensation operations.
  3. Improvement operations.
  4. Manufacture under license.
  5. Franchise.
  6. Cooperation.
  7. Project companies abroad.
  8. Independent intermediaries.

Channels of merchandise distribution

In addition, merchandise distribution channels in foreign trade are classified as follows:

  • Direct: The distribution is made directly between the producer and the buyer, without the involvement of any national intermediary.
  • Indirect: They are carried out through special companies dedicated to foreign trade that act as intermediaries.

The editor recommends:

  • See international trade
  • See difference between international trade and foreign trade