Trade Economics

1. Differentiate between the balance of payments and the balance of trade.

   Trade is the prime source of the supply and demand for the US dollar. International investment opportunities are another source. Central bank trading and intervention is the third source. The accounting that keeps track of the types of supply and demand for US dollars is called the "Balance of Payments." Trade enters what is termed the Current Account. The Capital Account measures investment flows. Finally, activities by central banks are accounted for in Official Financing (reserves). This balances the Balance of Payments. When there is dis-equilibrium in the Balance of Payments, the exchange rate adjusts.

   When supply exceeds demand (payments exceed receipts) the exchange rate falls the US dollar is worth less, imports become more expensive to US buyers, exports become cheaper to foreign buyers, and the trade deficit falls.

   The balance of payments of a country can be divided into two sections: that of the capital account and that of the current account. The latter is divided again, into the visibles account (often termed the balance of trade) and the invisibles. Visibles are products of primary and secondary industries (loosely termed as goods), while invisibles are services, transfers, or IPD (interest, profits and dividends). The balance of trade is then defined as a subpart of the balance of payments.

   It is important to note that every transaction in the balance of payments ledger gives rise to both a debit and a credit. Consequently, the balance of payments must always balance in an accounting sense. The balance of payments "imbalances" result from looking at just one portion of the ledger, such as the net Balance of Trade. (Trade deficit)

2. How does the product life cycle of trade theory work?
   Raymond Vernon of the Harvard Business School developed this theory in the 1960's. It includes three stages: stage one is the development of a new product; stage two is the maturing of a product; and stage three is the production of a standardized product. The firm that develops a new product sells it primarily to the domestic market in stage 1 and starts exporting the product in stage 2. In stage 3, when the product becomes a "commodity" (standardized; same quality no matter where produced), the country that developed the new product becomes a net importer of the product.
   
3. If free trade is so great why do we not have absolutely free trade?
   For five reasons: 1) Protection of National Security. 2) Diversification of the Economy, 3) The protection of infant industries, 4) Protectionism of Jobs, 5) Protectionism of wages. Only the first three are of any merit since the latter two have been proven in various examples to usually increase with trade.
   
4. Differentiate between a free trade association and a common market.
   Free Trade Associations are the simpler of the two entities. These Non-governmental organizations or loosely organized groups of trading partners have one mission: to lower or eliminate trade tariffs between and among trading partners. Common Markets are more complex. These groups of trading partners not only have the reduction of tariffs in mind as a goal, but the free mobility of capital, labor and raw materials. An example of a common market is the European Union while an example of a Free Trade Association is NAFTA, EFTA or LAFTA.
   
5. Differentiate between an income tariff and a protective Tariff. How are each of these used on imports and exports?
   These two tariffs are different specifically in regards to the intent of each. In addition, they usually differ on the amount required to be paid by the supplier. The protective tariff seeks to limit the supply of a good from foreign country while protecting domestic interests and production. This tax is usually set very high to cause the supplier not to be able to supply the same quantity. Since this tariff will do little to increase duty derived revenue it differs from an income tariff. The income tariff is a tariff that adds to the coffers of the country that imposes it. Many small countries get the majority (35-40%) of their government income from duty derived revenue rather than citizen's income taxes. These tariffs are generally lower than protective tariffs because they do not want to limit supply to a point where they do not gain a fair amount of revenue. On imports, the protective tariff can be seen as a 200% ad valorum tax on the good. The income tariff could be a licensing fee or safety inspection tax that the supplier sees as a necessity to doing business, but does little to cut back on the quantity supplied. On the exports the protective tariff may have once taxed goods sent overseas so that the companies "selling out to the foreigners" would not have any unfair advantage over domestic business's, an example could be the Interest Equalization tax. The income tariff would be more inline with the domestic model of taxing the profits of the company in a corporate income tax. In sum protective tariffs protect the domestic market from almost certain efficiency and income tariffs grift the economic profits out of complex foreign ventures to pay for 'fat-cat' domestic social welfare.

 

Differentiate between these following four types of international investment:

 

Direct investment: Foreign direct investment for outsourcing purposes is usually undertaken by companies, in an advanced country, that are being forced to restructure in order to cope with changes in the business environment. Such restructuring involves shifting some resources out of declining sectors and into promising domestic sectors within the advanced country (diversification), while shifting other resources abroad in the form of foreign direct investment. The parent company then becomes linked to overseas subsidiaries via intra-firm trade. If this investment exceeds 10% of the voting share of a foreign entity the IRS deems it direct investment and taxes it as such.

Portfolio investment: Portfolio investment by foreign interests is, in essence, the purchase of bonds and other fixed­interest financial assets. Investment in Government bonds is a form of portfolio investment. Different country's reserve banks manage inflation by acting to increase portfolio investment inflows, thereby pushing up the exchange rate.

Directly productive investment: This is investment overseas in the form of factories and other productive means. This investment usually has direct measurable returns.

 

Social overhead investment: These are the roads, schools, bridges and other infrastructure that firms have to invest in order for their direct productive investments to pay off. Sometimes these are social obligations for making a profit in a foreign country. (A kind of payback for taking a rent from a factor of production in a country other than your own.)

 

Differentiate between these different international management terms:

 

Licensing: This is the act of a domestic producer selling the production secret and rights to produce to a foreign producer who produces your good for their market and possibly for export.

 

Management Contracts: These are the home companies managers and directors who supervise the operation overseas, but who operation is usually locally manned and built. This is a derivative of some turnkey operations where after starting the operation the home company leaves behind management under a management contract to operate the production.

 

Turnkey Operations: This is where a home company comes into a country, builds the factory or means of production, gets it running and then sells it or "turns the key over to local management."

 

IMSUB - Import substitution strategy - Policy of preventing imports in favor of homegrown production such that the country can become self-sufficient.

 

EXPRO - export-promotion strategy - Policy of identifying export industries, which, with government help, can produce considerable export sales. Often 100% of the goods produced are exported. (E.g. Wool jackets in Equatorial countries. Although no one wears them there they are produced and sold to add to the current account in the balance of payments.)

 

Discuss the sources of finance and their relative usage for firms in the USA, firms in Europe and firms in LDCs.