by Foreign trade enlarges the market for a country’s output. Exports may lead to increase in national output and may become an engine of growth. Expansion of a country’s foreign trade may energies an otherwise stagnant economy and may lead it onto the path of economic growth and prosperity.
Increased foreign demand may lead to large production and economies of scale with lower unit costs. Increased exports may also lead to greater utilization of existing capacities and thus reduce costs, which may lead to a further increase in exports. Expanding exports may provide greater employment opportunities. The possibilities of increasing exports may also reveal the underlying investment in a particular country and thus assist in its economic growth.
Some of the important ways in which foreign trade contributes to economic growth are as follows:
- The primary function of foreign trade is to explore means of procuring imports of capital goods, without which no process of development can start;
- Trade provides for flow of technology, which allows for increases in productivity, and also result in short-term multiplier effect;
- Foreign trade generates pressure for dynamic change through
(a) Competitive pressure from imports
(b) Pressure of competing export markets
(c) A better allocation of resources;
- Exports allow fuller utilization of capacity resulting in achievement of economies of scale, separates production pattern from domestic demand, increases familiarity with absorption of new technologies;
- Foreign trade increases most workers’ welfare. It does so at least in four ways:
(a) Larger exports translate into higher wages
(b) Because workers are also consumers, trade brings them immediate gains through products of imports
(c) It enables workers to become more productive as the goods they produce increase in value
(d) Trade increases technology transfers from industrial to developing countries resulting in demand for more skilled labour in the recipient countries.
- Increased openness to trade has been strongly associated with reduction in poverty in most developing countries. As the historian Arnold Toynbee said ‘civilization’ has been spread though ‘mimesis’, i.e. emulation or simply copying.
In short, trade promotes growth enhancing economic welfare by stimulating more efficient utilization of factor endowments of different regions and by enabling people to obtain goods from efficient sources of supply.
There are the two main sources of growth:
- Increase in the supplies of resources and
- Technological progress. The effect of growth on the volume of trade depends on the rates at which the output of the nation’s exportable and importable commodities grow and with the consumption pattern of the nation as its real per capita income increases through growth and trade.
The Effect of Growth on Trade: The Small-Country Case:
If the output of the nation’s exportable goods increases proportionately faster than that of its importable commodities at constant relative prices (or terms of trade), then growth tends to led to greater than proportionate expansion of trade. Economic growth has natural effect of leading to the same rate of expansion of trade.
On the other hand, if the nation’s consumption of its importable commodity increases proportionately more than the nation’s consumption of its exportable commodity, at constant prices, then the consumption effect tends to lead to a greater than proportionate expansion of trade. What in fact happens to the volume of trade in the process of growth depends on the net result of these production and consumption effects. This prediction is relevant for a small country which cannot influence world prices of tradable goods.
Growth and Trade: The Large-Country Case:
Economic growth is more relevant for one development of LDCs. If economic growth, what-ever its source may be, expands the nation’s volume of trade at constant prices, then the nation’s terms of trade (which is the ratio of the price index of exports to that of imports) tend to deteriorate. On the other hand, if growth reduces the nation’s volume of trade at constant prices, the nation’s terms of trade will improve. This is known as the terms-of-trade effect of growth.
The effect of economic growth on the nation’s welfare depends on the net result of terms-of-trade effect and a wealth effect. The wealth effect refers to the change in output per capita as a result of growth. A favourable wealth effect, by itself, tends to increase the nation’s welfare.
Otherwise, the nation’s welfare tends to decline or remain unchanged. If the wealth effect is positive and the nation’s terms of trade improve as a result of growth and trade, the nation’s welfare will surely improve. If they are both unfavourable, there is a loss of social welfare. If the wealth effect and the terms-of-trade effect move in opposite directions, the nation’s welfare may deteriorate, improve or remain unchanged depending on the relative strength of these two opposing forces.
Immeserising Growth:
Even if the wealth effect, by itself, tends to increase the nation’s welfare, the terms of trade may deteriorate so much that there a net loss of social welfare. This is termed as immeserising growth by Jagdish Bhagwati. The term refers to a situation in which a developing country’s attempt to increase its growth potential through exports actually results in a retardation of that potential.
This is very much an exceptional situation confined only in theory to a country where export speciality accounts for a major share of world trade in the product. The country needs to export more to earn the foreign exchange to finance the capital imports which it requires to accelerate its rate of economic growth.
If all its export effort is concentrated on its speciality, this could lead to an ‘oversupply’ of its product resulting in a deteriorating of the country’s terms of trade. As a result, the country’s foreign exchange earnings will now buy fewer imports and domestic growth potential will be impaired.
So long we briefly explained the effects of economic growth on a country’s foreign trade but not the other side of the coin, the effects of trade on growth. Those effects are much more important for developing countries, at least, from the policy point of view. It is to this issue that we may turn now.
Significance of Foreign Trade
- Division of labour and specialisation
Foreign trade leads to division of labour and specialisation at the world level. Some countries have abundant natural resources. They should export raw materials and import finished goods from countries which are advanced in skilled manpower. This gives benefits to all the countries and thereby leading to division of labour and specialisation.
- Optimum allocation and utilisation of resources
Due to specialisation, unproductive lines can be eliminated and wastage of resources avoided. In other words, resources are channelised for the production of only those goods which would give highest returns. Thus there is rational allocation and utilization of resources at the international level due to foreign trade.
- Equality of prices
Prices can be stabilised by foreign trade. It helps to keep the demand and supply position stable, which in turn stabilises the prices, making allowances for transport and other marketing expenses.
- 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.
- 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 standardised goods are produced.
- Raises standard of living of the people
Imports can facilitate 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.
- Generate employment opportunities
Foreign trade helps in generating employment opportunities, by increasing the mobility of labour and resources. It generates direct employment in import sector and indirect employment in other sector of the economy. Such as Industry, Service Sector (insurance, banking, transport, communication), etc.
- Facilitate economic development
Imports facilitate 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, i.e. agriculture, industry and service sector.
- 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.
- Maintains balance of payment position
Every country has to maintain its balance of payment position. Since, every country has to import, which results in outflow of foreign exchange, it also deals in export for the inflow of foreign exchange.
- Brings reputation and helps earn goodwill
A country which is involved in exports earns goodwill in the international market. For e.g. Japan has earned a lot of goodwill in foreign markets due to its exports of quality electronic goods.
- Promotes World Peace
Foreign trade brings countries closer. It facilitates 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.
Merits of Foreign Trade
(i) Optimal use of natural resources:
International trade helps each country to make optimum use of its natural resources. Each country can concentrate on production of those goods for which its resources are best suited. Wastage of resources is avoided.
(ii) Availability of all types of goods:
It enables a country to obtain goods which it cannot produce or which it is not producing due to higher costs, by importing from other countries at lower costs.
(iii) Specialisation:
Foreign trade leads to specialisation and encourages production of different goods in different countries. Goods can be produced at a comparatively low cost due to advantages of division of labour.
(iv) Advantages of large-scale production:
Due to international trade, goods are produced not only for home consumption but for export to other countries also. Nations of the world can dispose of goods which they have in surplus in the international markets. This leads to production at large scale and the advantages of large scale production can be obtained by all the countries of the world.
(v) Stability in prices:
International trade irons out wild fluctuations in prices. It equalizes the prices of goods throughout the world (ignoring cost of transportation, etc.)
(vi) Exchange of technical know-how and establishment of new industries:
Underdeveloped countries can establish and develop new industries with the machinery, equipment and technical know-how imported from developed countries. This helps in the development of these countries and the economy of the world at large.
(vii) Increase in efficiency:
Due to international competition, the producers in a country attempt to produce better quality goods and at the minimum possible cost. This increases the efficiency and benefits to the consumers all over the world.
(viii) Development of the means of transport and communication:
International trade requires the best means of transport and communication. For the advantages of international trade, development in the means of transport and communication is also made possible.
(ix) International co-operation and understanding:
The people of different countries come in contact with each other. Commercial intercourse amongst nations of the world encourages exchange of ideas and culture. It creates co-operation, understanding, cordial relations amongst various nations.
(x) Ability to face natural calamities:
Natural calamities such as drought, floods, famine, earthquake etc., affect the production of a country adversely. Deficiency in the supply of goods at the time of such natural calamities can be met by imports from other countries.
(xi) Other advantages:
International trade helps in many other ways such as benefits to consumers, international peace and better standard of living.
Demerits of Foreign Trade
Over-Dependence
Countries or companies involved in the foreign trade are vulnerable to global events. An unfavorable event may impact the demand of the product, and could even lead to job losses. For instance, the recent US-China trade war is adversely affecting the Chinese export industry.
Unfair to New Companies
New companies or start-ups who don’t have much resources and experience may find it difficult to compete against the big foreign firms.
A Threat to National Security
If a country is over dependent on the imports for strategic industries, then exporters may force it to take a decision that may not be in the national interest.
Pressure on Natural Resources
A country only has limited natural resources. But, if it opens its doors to the foreign companies, it could drain those natural resources much quicker.
