Module 2

INTERNATIONAL BUSINESS ASMIT SHAH : 9824289094
Module II
International Trade
Introduction : By internal or domestic trade are meant transactions taking place

within the geographical boundaries of a nation or region. It is also known as intra-
regional or home trade. International trade, on the other hand, is trade among
different countries or trade across political frontiers.
Definitions :
According to Wasserman and Haltman, International trade consists of
transaction between residents of different countries.
According to Anatol Marad, International trade is a trade between nations.
According to Eugeworth, International trade means trade between nations.
Meaning : All countries need goods and services to satisfy wants of their people.
Production of goods and services requires resources. Every country has only
limited resources. No country can produce all the goods and services that it
requires. It has to buy from other countries what it cannot produce or can
produce less than its requirements. Similarly, it sells to other countries the goods
which it has in surplus quantities. India too, buys from and sells to other countries
various types of goods and services.
Generally no country is self-sufficient. It has to depend upon other countries for

importing the goods which are either non-available with it or are available in
insufficient quantities. Similarly, it can export goods, which are in excess quantity
with it and are in high demand outside.
International trade, thus, refers to the exchange of goods and services between
one country or region and another. It is also sometimes known as inter-regional
or foreign trade. Briefly, trade between one nation and another is called
international trade, and trade within the territory (political boundary) of a
nation internal trade.
PREPARED BY : PRUTHVIRAJSINH N RATHOD 9662051243

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For all practical purposes, trade or exchange of goods between two or more
countries is called international or foreign trade. Trade between two or more
countries is called foreign trade or international trade. This involves the exchange
of goods and services between the citizens of two countries. When citizens of one
country exchange goods and services with the citizens of another country, it is
called foreign trade.
Characteristics of International Trade:

(i) Separation of Buyers and Producers: In inland trade producers and buyers are
from the same country but in foreign trade they belong to different countries.
(ii) Foreign Currency: Foreign trade involves payments in foreign currency.
Different foreign currencies are involved while trading with other countries.
(iii) Restrictions: Imports and exports involve a number of restrictions but by
different countries. Normally, imports face many import duties and restrictions
imposed by importing country. Similarly, various rules and regulations are to be
followed while sending goods outside the country.
(iv) Need for Middlemen: The rules, regulations and procedures involved in
foreign trade are so complicated that there is a need to take the help of middle
men. They render their services for smooth conduct of trade.
(v) Risk Element: The risk involved in foreign trade is much higher since the goods
are taken to long distances and even cross the oceans.
(vi) Law of Comparative Cost: A country will specialise in the production of those
goods in which it has cost advantage. Such goods are exported to other countries.
On the other hand, it will import those goods which have cost disadvantage or it
has no specific advantage.
(vii) Governmental Control: In every country, government controls the foreign
trade. It gives permission for imports and exports may influence the decision
about the countries with which trade is to take place.
Need for International Trade: In todays world, economic life has become more
complex and diversified. No country can live in isolation and claim to be self-
sufficient. Even countries with different ideologies, culture, and political, social

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and economic structure have trade relations with each other. Thus, trade relations
of U.S.A. with U.S.S.R. and China with Japan are examples. The aim of
international trade is to increase production and to raise the standard of living of
the people. International trade helps citizens of one nation to consume and enjoy
the possession of goods produced in some other nation.
There is a need of international trade due to the following reasons:

(i) Uneven Distribution of Natural Resources: Natural resources of the world are
not evenly divided among the nations of the world. Different countries of the
world have different amount of natural resources and they differ with each other
in regard to climate, minerals and other factors.
(ii) Division of Labour and Specialisation: Due to uneven distribution of natural
resources, some countries are more suitably placed to produce some goods more
economically than other countries. But they are geographically at a
disadvantageous position to produce other goods.
(iii) Differences in Economic Growth Rate: There are many differences in the
economic growth rate of different countries. Some countries are developed some
are developing, while there are some other countries which are under-developed:
these under-developed and developing countries have to depend upon developed
ones for financial help, which ultimately encourages international trade.
(iv) Theory of Comparative Cost: According to the theory of comparative cost,
each country should concentrate on the production of those goods for which it is
best suited, taking into account its natural resources, climate, labour supply,
technical know-how and the level of development.
This reduces the cost of production all over the world and improves the standard
of living of the people in various countries. Hence the theory of comparative cost
encourages international trade.
Advantages of International Trade:

(1) Optimum Allocation: International specialisation and geographical division of
labour leads to the optimum allocation of worlds resources, making it possible to
make the most efficient use of them.

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(2) Gains of Specialisation: Each trading country gains when the total output
increases as a result of division of labour and specialisation. These gains are in the
form of more aggregate production, larger number of varieties and greater
diversity of qualities of goods that become available for consumption in each
country as a result of international trade.
(3) Enhanced Wealth: Increase in the exchangeable value of possessions, means

of enjoyment and wealth of each trading country.
(4) Larger Output: Enlargement of worlds aggregate output.
(5) Welfare Contour: Increase in the worlds prosperity and economic welfare of
each trading nation.
(6) Cultural Values: Cultural exchange and ties among different countries develop
when they enter into mutual trading.
(7) Better International Politics: International trade relations help in harmonising

international political relations.
(8) Dealing with Scarcity: A country can easily solve its problem of scarcity of raw
materials or food through imports.
(9) Advantageous Competition: Competition from foreign goods in the domestic

market tends to induce home producers to become more efficient to improve and
maintain the quality of their products.
(10) Larger size of Market: Because of foreign trade, when a countrys size of
market expands, domestic producers can operate on a larger scale of production
which results in further economies of scale and thus can promote development.
Synchronised application of investment to many industries simultaneously
become possible. This helps industrialisation of the country along with balanced
growth.
Disadvantages of International Trade:

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1. Exhaustion of Resources: When a country has larger and continuous exports,

her essential raw materials and minerals may get exhausted, unless new resources
are tapped or developed (e.g., the near-exhausting oil resources of the oil-
producing countries).
2. Blow to Infant Industry: Foreign competition may adversely affect new and
developing infant industries at home.
3. Dumping: Dumping tactics resorted to by advanced countries may harm the

development of poor countries.
4. Diversification of Savings: A high propensity to import may cause reduction in

the domestic savings of a country. This may adversely affect her rate of capital
formation and the process of growth.
5. Declining Domestic Employment: Under foreign trade, when a country tends to

specialize in a few products, job opportunities available to people are curtailed.
6. Over Interdependence: Foreign trade discourages self-sufficiency and self-

reliance in an economy. When countries tend to be interdependent, their
economic independence is in risk.
Differences between Internal Trade and International Trade:
1. Specific Terms:
Exports and Imports. Internal trade is the exchange of domestic output within the
political boundaries of a nation, while international trade is the trade between
two or more nations. Thus, unlike internal trade, the terms export and import
are used in foreign trade. To export means to sell goods to a foreign country. To
import goods means to buy goods from a foreign country.

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2. Heterogeneous Group:
An obvious difference between home trade and foreign trade is that trade within
a country is trade among the same group of people, whereas trade between
countries takes place between differently cohered groups. The socio-economic
environment differs greatly between nations, while it is more or less uniform
within a country. Frederick List, therefore, put that: Domestic trade is among us,
international trade is between us and them.
3. Political Differences:
International trade occurs between different political units, while domestic trade
occurs within the same political unit. The government in each country is keen
about the welfare of its own nationals against that of the people of other
countries. Hence, in international trade policy, each government tries to see its
own interest at the cost of the other country.
4. Different Rules:
National rules, laws and policies relating to trade, commerce, industry, taxation,
etc. are more or less uniform within a country, but differ widely between
countries.
Tariff policy, import quota system, subsidies and other controls adopted by a
government interfere with the course of normal trade between it and other
countries. Thus, state interference causes different problems in international trade
while the value of theory, in its pure form, which is laissez faire, cannot be applied
in toto to the international trade theory.
5. Different Currencies:
Perhaps the principal difference between domestic and international trade is that
the latter involves the use of different types of currencies and each country
follows different foreign exchange policies. That is why there is the problem of
exchange rates and foreign exchange. Thus, one has to study not only the factors
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which determine the value of each countrys monetary unit, but also the divergent
practices and types of exchange resorted to.
6. Heterogeneous World Markets:
In a way, home trade has a homogeneous market. In foreign trade, however, the
world markets lack homogeneity on account of differences in climate, language,
preferences, habits, customs, weights and measures etc.
The behaviour of international buyers in each case would, therefore, be different.

For instance, Indians have right-hand drive cars, while Americans have left-hand
driven cars. Hence, the markets for automobiles are effectively separated. Thus,
one peculiarity of international trade is that it involves heterogeneous national
markets.
7. Factor Immobility:
Another major difference between internal and international trade is the degree
of immobility of factors of production like labour and capital which is generally
greater between countries than within the country. Immigration laws, citizenship
qualifications, etc., often restrict international mobility of labour. International
capital flows are prohibited or severely limited by different governments.
Theories of International trade:
Adam Smith and David Ricardo gave the classical theories of international trade.
According to the theories given by them, when a country enters in foreign trade, it
benefits from specialization and efficient resource allocation. The foreign trade
also helps in bringing new technologies and skills that lead to higher productivity.
The assumptions taken under this theory are as follows:

a. There are two countries producing two goods.
b. The size of economies of these countries is equal
c. There is perfect mobility of factors of production within countries
d. Transportation cost is ignored
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e. Before specialization, countrys resources are equally divided to produce each

good
1 .Theory of Mercantilism:
Mercantilism is the term that was popularized by Adam Smith, Father of
Economics, in his book, The Wealth of Nations. Western European economic
policies were greatly dominated by this theory. The theory of mercantilism holds
that countries should encourage export and discourage import.
It states that a countrys wealth depends on the balance of export minus import.
According to this theory, government should play an important role in the
economy for encouraging export and discouraging import by using subsidies and
taxes, respectively. In those days, gold was used for trading goods between
countries.
Thus, export was treated as good as it helped in earning gold, whereas, import
was treated as bad as it led to the outflow of gold. If a nation has abundant gold,
then it is considered to be a wealthy nation. If all the countries follow this policy,
there may be conflicts, as no one would promote import. The theory of
mercantilism believed in selfish trade that is a one-way transaction and ignored
enhancing the world trade. Mercantilism was called as a zero-sum game as only
one country benefitted from it.
2.Theory of Absolute Advantage:

Given by Adam Smith in 1776, the theory of absolute advantage stated that a
country should specialize in those products, which it can produce efficiently. This
theory assumes that there is only one factor of production that is labor.
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Adam Smith stated that under mercantilism, it was impossible for nations to
become rich simultaneously. He also stated that wealth of the countries does not
depend upon the gold reserves, but upon the goods and services available to their
citizens.
Adam Smith wrote in The Wealth of Nations, If a foreign country can supply us
with a commodity cheaper than we ourselves can make it, better buy it of them
with some part of the produce of our own industry, employed in a way in which
we have some advantage.
He stated that trade would be beneficial for both the countries if country A
exports the goods, which it can produce with lower cost than country B and
import the goods, which country B can produce with lower cost than it.
An example can be used to prove this theory. Suppose there are two countries A
and B, which produce tea and coffee with equal amount of resources that is 200
laborers. Country A uses 10 laborers to produce 1 ton of tea and 20 laborers to
produce 1 ton of coffee. Country B uses 25 units of laborers to produce tea and 5
units of laborers to produce 1 ton of coffee.
This is shown in Table- 1:
It can be seen from Table-2 that country A has absolute advantage in producing
tea as it can produce 1 ton of tea by using less laborers as compared to country B.
On the other hand, country B has absolute advantage in producing coffee as it can
produce 1 ton of coffee by employing less laborers in comparison to country A.
Now, if there is no trade between these countries and resources (in this case there
are total 200 laborers) are being used equally to produce tea and coffee, country
A would produce 10 tons of tea and 5 tons of coffee and country B would produce

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4 tons of tea and 20 tons of coffee. Thus, total production without trade is 39 tons
(14 tons of tea and 25 tons of coffee).
Table-2 shows the production without the trade between country A and country
B:
If both the countries trade with each other and specialize in goods in which they
have absolute advantage, the total production would be higher. Country A would
produce 20 tons of tea with 200 units of laborers; whereas, country B would
produce 40 tons of coffee with 200 units of laborers. Thus, total production would
be 60 units (20 tons of tea and 40 tons of coffee).
The production of tea and coffee after trade is shown in Table-3:
Without specialization, total production of countries was 39 tons, which becomes

60 tons after specialization. Therefore, the theory of absolute advantages shows
that trade would be beneficial for both the countries.
3.Theory of Comparative Advantage:

Many questions may come in mind after reading the absolute advantage theory
that what would happen if a country has absolute advantage in all the products or
no absolute advantage in any of the product. How such a country would benefit
from trade? The answers of these questions was given by David Ricardo in his
theory of comparative advantage, which states that trade can be beneficial for
two countries if one country has absolute advantage in all the products and the
other country has no absolute advantage in any of the products.

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According to Ricardo, a nation, like a person, gains from the trade by exporting
the goods or services in which it has its greatest comparative advantage in
productivity and importing those in which it has the least comparative advantage.
This theory assumes that labor as the only factor of production in two countries,
zero transport cost, and no trade barriers within the countries. Let us understand
this theory with the help of an example.
Suppose there are two countries A and B, producing two commodities wheat and
wine with labor as the only factor of production. Now assume that both the
countries have 200 laborers and they use 100 laborers to produce wheat and 100
laborers to produce wine.
Table-4 shows the production of wheat and wine in Country X and Country Y
before trade:
Table-4 depicts that country X can produce 20 units; whereas, country Y can
produce 15 units of wheat by using 100 laborers. In addition, country X can
produce 40 units; whereas, country Y can produce 10 units of wine by employing
100 laborers.
Thus, country X has absolute advantage in producing both the products. As

already discussed, country X employs same number of laborers (100 laborers in
production of each good) in producing both wine and wheat; however, the
production of wine is more than the production of wheat.
It shows that country X has comparative advantage in producing wine. Similarly,

country Y also employs same number of laborers (100 laborers in production of
each good) in manufacturing wheat and wine; however, its production of wheat is
more than the wine. It indicates that country Y has comparative advantage in
manufacturing wheat.
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For example, country X has decided to produce 60 units of wine by employing 150
laborers. It uses 50 laborers to produce 10 units of wheat. On the other hand,
country Y has decided to use all the 200 laborers to produce 30 units of wheat. It
would not produce any unit of wine.
Now, country X exchanges 14 units of wine with 14 units of wheat produced by

country Y.
The situation of both the countries after trade is shown in Table-6:
It can be observed from Table-6 that both the countries have gained from trade.
Before trade, country X has 20 units of wheat and 40 units of wine; however, after
trade, country Y has 24 units of wheat and 46 units of wine.
On the other hand, country Y has 15 units of wheat and 10 units of wine before
trade; however, it has 16 units of wheat and 14 units of wine after trade.
Therefore, comparative advantage explains that trade can create benefit for both
the countries even if one country has absolute advantage in the production of
both the goods.
4 .Heckscher-Ohlin Theorem of International Trade

As a matter of fact, Ohlins theory begins where the Ricardian theory of
international trade ends. The Ricardian theory states that the basis of
international trade is the comparative costs difference. But he did not explain how
after all this comparative costs difference arises.
Ohlins theory explains the real cause of this difference. Ohlin did not invalidate
the classical theory but accepted the comparative advantage as the cause of
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international trade and then tried to examine and analyse it further in a moral and
logical manner. Thus, Ohlins theory supplements but does not supplant the
Ricardian theory
1. Two countries A and will involve themselves in trade, if relative price of goods
X and Y are different. To quote Ohlin, the immediate cause of inter-regional trade
is always that goods can be bought cheaper from outside in terms of money than
they can be produced at home.
2. Under comparative market conditions, prices are equal to average costs. Thus,
relative price differences are an account of cost differences.
3. Cost differences are taking place because of the factor price differences in the
two countries.
4. Factor prices are determined by factors supply and demand. Assuming a given
demand, it follows that a capital-rich country has a cheaper or a lower capital
price and a labour-abundant country has a relatively lower labour price.
In our model, thus, factor-price ratio Price of Labour/Price of Capital in country A

is lower than the ratio Price of Labour/Price of Capital in B.
5. Ohlin states that each region has advantages in the production of goods into
which enter considerable amounts of factors abundant and cheap in that region.
Since X is a labour-intensive product in country A, it will be cheaper than in B,

because labour is relatively cheaper in A. Similarly Y, the capital- intensive product
in country B, is relatively cheaper as is a capital-rich country and the price of
capital is relatively lower.
6. It follows that country A will tend to specialise in the production of X and export
its surplus. Likewise, will specialise in Y and export it.

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In short, a capital-rich and capital-cheap country exports capital intensive

products while a labour-abundant and labour-cheap country exports labour-
intensive products.
It also follows that trade takes place because of factor-endowment difference and
their international immobility. Sodersten writes, In a world where factors of
production cannot move among countries but where goods can move freely, trade
in goods can be viewed as a substitution for factor mobility.
Thus, Ohlins theory concludes that:

i. The basis of internal trade is the difference in commodity prices in the two
countries.
ii. Differences in commodity prices are due to cost differences which are the
results of differences in factor endowments in the two countries.
iii. A capital-rich country specialises in labour-intensive goods and exports them. A

labour-abundant country specialises in labour-intensive goods and exports them.
Ohlin gives the illustration of Australia and England in support of his theory. In
Australia, land is plenty and cheap, while labour and capital are scanty and dear.
So, Australia specialises in goods like wheat, wool, meat, etc., which are relatively
produced cheaper here on account of their specific production functions requiring
a larger proportion of land but little use of capital. On the other hand, England is
capital-rich but labour- poor.
Thus, goods requiring plenty of capital will tend to be relatively cheaper in

England. Examining the trade between England and Australia, it may be observed
that Australia imports manufactured or capital-intensive goods from England and
exports wheat, meat, etc. Thus, Australias import is indirectly an import of scarce
factors and her export is indirectly an export of factors in abundant supply.
Modren theories
1. International Product Life - Cycle Theory:
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This theory attempts to explain the impact of a products life-cycle stage on flow
of its trade (where a product would be manufactured and where it would be in
demand) According to this theory shifts in manufacturing and trade flow of a
product goes through four phases which are in the following;
1. New product stage A product will be initially produced & sold mostly in the
country in which it is developed (nearby observed need & market). For most
advanced and technology products these will initially be conceptualized in
developed countries and sold in these markets
2.Growth stage : At the next stage, the market for the successful product would
start to rapidly grow.Inthis stage the product would be produced in the innovating
and other industrial countries and sold in many industrial countries.
3.Mature stage : Reaching the maturity stage market for a product would become
competitive and buyer would become experienced. As the result margins on the
product would decline and competitive pressured would require the
manufacturers to seek lower production costs. At
this stage production of the products shifts from industrialized countries to
countries where costs are lower the innovating country may stop producing &
start importing
4.Decline stage : At this stage demand for the product declines, especially in
advanced countries, as other more effective technologies and products are
introduced. At this stage production and market of the product is mainly in less
developed countries
Exceptions
There are however, exceptions to the impact of the life-cycle on a products
manufacturing locations and trade. Products with very short product-lifecycles,
luxury Products where cost are less important, products requiring specialized
skills, strategic products of a country, differentiated products (i.e., differentiated
on country of origin, such as hand made Italian
leather fashion products ) will experience less, if any, impact of a life-cycle stage.
2.Global Strategic Rivalry Theory:

This theory was forwarded in 1980 by Paul Krugman. He studied firms that were
SHAH ACADEMY 15
successful incompeting in international markets and concluded that;

Firms struggle to dominate world markets by
Owning intellectual property rights
Investing in research & development
Achieving economies of scale & scope
Exploiting the experience curve
Such firms that were innovative and could establish competitive advantages by
owning intellectual property rights to useful technologies, that pursued research
and development aggressively, that strived to achieve economies of scale and
scope and that were learning organization and could become more efficient with
time were able to succeed in international competition.
3.Porters Theory of National Competitive Advantage:

Professor Michael Porter combined the country specific and firm specific factors
to explain how firms and industries of certain countries are able to achieve
success in international markets. Thistheorywasforwardedin1990.
According to Porters Theory of National Competitive Advantage success in

international trade comes from the interaction of four country - and firm - specific
elements; Factor conditions : abundance and quality of land, raw materials,
labor, capital educational level of workforce, countrys infrastructure etc. The
factors that are need essentially for producing certain products and services.
Demand conditions : large sophisticated domestic market stimulated
development and distribution of innovative products which may also be exported
most new innovative products are first developed by firms for domestic markets
and then sold in other countries. If domestic
markets are not sophisticated and large, domestic firms may not have the
opportunity to conceptualize and produce innovative products and to develop
skills and resources needed for successful international marketing.
Related and supporting industries: today most products require many complex
technologies for successful manufacturing and it is difficult for any one firm to
master all the aspects of all the needed technologies and skills. Firms therefore,

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need to collaborate with other firms as buyer sand suppliers to develop final
products. Industries of any country that are successful in international markets are
the ones where related and supporting firms are co-located in proximity to allow
effective and efficient transactions and collaborations.
Firm strategy, structure & rivalry : presence of a competitive domestic market
forces local firms to focus efforts in skills training, strategizing and r&d that
eventually shapes companies to reduce costs & become competitive
internationally.
Foreign Trade Multiplier:

Meaning: The foreign trade multiplier, also known as the export multiplier,
operates like the investment multiplier of Keynes. It may be defined as the
amount by which the national income of a country will be raised by a unit increase
in domestic investment on exports.
As exports increase, there is an increase in the income of all persons associated
with export industries. These, in turn, create demand for goods. But this is
dependent upon their marginal propensity to save (MPS) and the marginal
propensity to import (MPM). The smaller these two marginal propensities are, the
larger will be the value of the multiplier, and vice versa.
Its working:
The foreign trade multiplier process can be explained like this. Suppose the
exports of the country increase. To begin with, the exporters will sell their
products to foreign countries and receive more income. In order to meet the
foreign demand, they will engage more factors of production to produce more.
This will raise the income of the owners of factors of production. This process will
continue and the national income increases by the value of the multiplier. The
value of the multiplier depends on the value of MPS and MPM, there being an
inverse relation between the two propensities and the export multiplier.
The foreign trade multiplier can be derived algebraically as follows:

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The national income identity in an open economy is

Y=C+I+XM
Where Y is national income, C is national consumption, I is total investment, X is
exports and M is imports.
The above relationship can be solved as:
Y-C = 1 + X-M
or S = I+X-M (S=Y-C)
S+M=I+X
Thus at equilibrium levels of income the sum of savings and imports (S+M) must
equal the sum of investment and export (1+X).
In an open economy the investment component (I) is divided into domestic
investment (Id) and foreign investment (If)
I=S
Id + If = S (1)
Foreign investment (If) is the difference between exports and imports of goods
and services.
If =X-M. (2)
Substituting (2) into (1), we have
ld+ X-M S
or Id + X = S+M
Which is the equilibrium condition of national income in an open economy. The
foreign trade multiplier coefficient (Kf) is equal to
Kf = Y/X
And X = S + M

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It shows that an increase in exports by Rs. 1000 crores has raised national income
through the foreign trade multiplier by Rs. 2000 crores, given the values of MPS
and MPM.
Its Assumptions:
The foreign trade multiplier is based on the following assumptions:

1. There is full employment in the domestic economy.
2. There is direct link between domestic and foreign country in exporting and
importing goods.
3. The country is small with no foreign repercussion effects.
4. It is on a fixed exchange rate system.
5. The multiplier is based on instantaneous process without time lags.
6. There is no accelerator.
7. There are no tariff barriers and exchange controls.
8. Domestic investment (Id) remains constant.

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9. Government expenditure is constant.

10. The analysis is applicable to only two countries.
Criticisms of Foreign Trade Multiplier:
The two models of the foreign trade multiplier presented above are based on
certain assumptions which make the analysis unrealistic.
1. Exports and Investment not Independent:

The analysis of simple foreign trade multiplier is based on the assumption that
exports and investment (both domestic and foreign) are independent of changes
in the level of national income. But, in reality, this is not so. A rise in exports does
not always lead to increase in national income. On the contrary, certain imports,
of say capital goods, have the effect of increasing national income.
2. Legless Analysis:
The foreign trade multiplier is assumed to be an instantaneous process whereby it
provides the final results. Thus it involves no lags and is unrealistic.
3. Full Employment not Realistic:

The analysis is based on the assumption of a fully employed economy. But there is
less than full employment in every economy. Thus the foreign trade multiplier
does not find clear expression in an economy with less than full employment.
4. Not Applicable to More than two Countries:

The whole analysis is applicable to a two-country model. If there are more than
two countries, it becomes complicated to analyse and interpret the foreign
repercussions of this theory.
5. Neglects Trade Restrictions:

The foreign trade multiplier assumes that there are no tariff barriers and exchange
controls. In reality, such trade restrictions exist which restrict the operations of the
foreign trade multiplier.
6. Neglects Monetary-Fiscal Measures:

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This analysis is based on the unrealistic assumption that the government

expenditure is constant. But governments always interfere through monetary and
fiscal policies which affect exports, imports and national income. Despite these
shortcomings, the foreign trade multiplier is a powerful tool of economic analysis
which helps in formulating policy measures.
Government Intervention in International Trade

1. National Security Argument: Each nation protects some industries to guard its
national security. The most obvious examples are weapons, aerospace, advanced
electronics, semiconductors, and strategic minerals (e.g., exotic ores used in jet
aircraft), etc. Protection for the sake of making available specific minerals or
resources does not appear to be an optimal policy. A better alternative is to
stockpile such resources during peacetime when they are cheap.
2. Foreign Policy Goals Argument: Commerce has become an important tool to

achieve foreign policy goals. Preferential treatment may be given to a country or
countries with which strong relations are to be built. Pakistan was rewarded when
it provided its airbase to the US during the Afghan war. Iraq was punished through
imposition of trade sanctions after it invaded Kuwait. Iran, North Korea and Libya
were also in the list of unfavorable nations of the US. India was denied high tech
computers when it exploded nuclear bomb in 1998.
3. Strategic Trade Policy Argument: P. Krugman proposed a new trade theory. The
theory argues that an industry has economies of scale and the world market will
profitably support only few firms. Countries may predominate in export of certain
products simply because they had firms who were able to capture first-mover
advantages. The dominance of Boeing in the commercial aircraft industry is
attributed to such factors.
The governments of Britain, France, Germany and Spain had given a subsidy of
$13.5 billion to Airbus. The US government had also given huge R&D grant to
Boeing during 1950w and 1960s. Japanese government did the same for Japanese

SHAH ACADEMY 21
semi-conductor industry to compete with the first-mover advantage-holder semi-

conductor industry of the US.
4. Safety Argument: Governments have all over been concerned to protect

consumers from unsafe products. Most countries prohibit imports of marijuana
and products made from endangered animal species. The US in its desire to
increase public safety, permanently banned in 1978 the imports of 58 types of
military-style assault weapons. Chile restricted imports of Salmon eggs by
contending that they might be diseased. The EU banned the import of hormone-
treated beef to protect its populace from the probable negative health
consequences.
Many of the EU nations, such as, Germany, Switzerland, Austria, and Luxembourg
are against genetically altered organisms. Developed countries are very tough
with regard to quality when the agri commodities come from developing
countries.
5. Emotional Argument: Many arguments may have no economic rationale but

they are so strong that no logic works. Rice is a very emotional issue among the
Japanese. For years it has been told that rice grown outside Japan is not suitable
for their palates and also not healthy. China limits rice import since rice farming
has been a historical and cohesive force in uniting Chinese families.
Preserving cultural identity and heritage has been a very strong argument.
Countries, at times, prohibit import of products and services that might
undermine this identity. The French government protects its movie industry by
limiting foreign films on French television and gives subsidies to the French film
makers to produce films.
It is out of fear that the English language and Anglo-Saxon culture will weaken its
cultural identity. Similarly, Canada limits foreign publishing, cable TV, bookselling,
and musical performance. India does not allow foreign investment in print media
out of emotions.

SHAH ACADEMY 22
Free Trade Policy: Policy of non-interference by government in foreign trade is

referred to as free trade. Free trade policy implies absence of any artificial
restriction on or obstacle to the freedom of trade of a country with other nations.
According to Adam Smith, the term free trade is used to denote that system of
commercial policy which draws no distinction between domestic and foreign
commodities and, therefore, neither imposes additional burdens on the latter, nor
grants any special favour to the former.
In other words, free trade implies complete freedom of international exchange.

Under such a policy there are no barriers to the movement of goods among
countries and exchange can take its perfectly natural course.
Advantages of Free Trade:
1. Comparative cost advantage: Free trade is the natural outcome of the

comparative costs advantage. It permits an allocation of resources, and manpower
in accordance with the principle of comparative advantage, which is just an
extension of the principle of division of labour. Free trade leads to the most
efficient conduct of economic affairs
2. More factor earnings: Under free trade, factors of production will also be able
to earn more, as they will be employed for better use. Hence, wages, interest and
rent will be higher under free trade than otherwise.
3. Cheaper imports: Free trade procures import at cheap rates. It seems to be an
attractive argument in favour of trade at least from the customers point of view.
4. Enlarged market: Free trade widens the size of the market as a result of which
greater specialisation and a more complex division of labour become possible.
This brings about optimum production with costs reduced everywhere, benefiting
the world as a whole.
5. Competition: Free trade policy encourages competition from abroad which
induces domestic producers to become more alert and improve their efficiency.
6. Restricted exploitation: Free trade prevents growth of domestic monopolies
and consumers exploitation due to competition from abroad.
SHAH ACADEMY 23
7. Greater welfare: Free trade permits large varieties of consumption goods and
improves consumers welfare.
Disadvantages of Free Trade:
1. Free trade policy runs smoothly if all the countries follow the same. If some
countries do not adopt it, the system cannot work gainfully.
2. Free trade may prove advantageous to developed and technologically advanced
nations, but less developed countries are certainly at a disadvantage on account
of unfavourable terms of trade.
3. Competition induced under free trade is unfair and unhealthy. Backward
countries cannot compete with advanced countries.
4. Gains of trade are not equally distributed under free trade due to unequal state
of development of different countries.
5. A country with unfavourable balance of payments finds it difficult to overcome
this situation under free trade policy.
6. Free trade may encourage interdependence and discourage self-sufficiency. But,
in the matter of defence each country should have self-reliance and self-
sufficiency as far as possible.
Free trade policy has been abandoned by all countries for the following reasons:
(i) Under the system of free trade, the underdeveloped countries suffer very much
in competing with the advanced countries. For instance, free trade policy in India
adopted by the British Government proved that the onetime flourishing industries
(handicrafts) of India were completely wiped out due to foreign competition.
(ii) Governments under free trade observed political handicaps due to economic
interdependence. For political independence, economic independence was
inevitable; hence free trade had to go.
(iii) Countries cannot allow free import of injurious and harmful products; hence
trade restrictions are necessary.

SHAH ACADEMY 24
(iv) Free trade led to cut-throat competition in the world market, so that exporters
resorted to dumping, which no government can allow beyond a limit; thus,
restrictions become inevitable.
(v) Backward countries have to protect their infant industries and hence cannot
adopt the policy of free trade.
Protectionism
Protectionism is the economic policy of restraining trade between states through
methods such as tariffs on imported goods, restrictive quotas and a variety of
other government regulations designed to allow (according to proponents) fair
competition between imports and goods and services produced domestically.
Sometimes, the prevailing market conditions may be viewed as unfavourable by a

country. It may therefore seek to put barriers in the way of foreign trade, i.e. it
may put restrictions on trade. This type of policy is known as protection.
Arguments in favour:
i. Without protection, these infant industries will not survive competition from
abroad. Protection will allow such industries to grow and become more efficient.
ii. Protection is required to prevent the establishment of a foreign- based
monopoly so as to prevent mis-utilisation of resources.
iii. Protection is required to prevent dumping and other unfair trade practices by
foreign producers.
iv. Trade restrictions are imposed to reduce the influence of trade on consumer
tastes. Some restrictions on trade may be justified in order to reduce producer
sovereignty of the MNCs.
v. Protection helps to reduce reliance on goods with little dynamic potential. Many
countries have traditionally exported primary commodities. The world demand for
these commodities is income inelastic and thus grows relatively slowly. In such
cases, free trade is not an engine of growth.
vi. Protection is required to spread the risks of fluctuating markets. Greater
diversity and greater self-sufficiency can reduce these risks.
SHAH ACADEMY 25
vii. Trade restrictions also help a country to improve its terms of trade by
exploiting its market power.
viii. Protection is required to take account of externalities. Free trade tends to
reflect private costs ignoring the associated externalities. Trade restrictions could
be designed to deflect these externalities.
ix. Restrictions are required to prevent the import of harmful goods.
Arguments against Protectionism
i. Protection to achieve some objective may be at a very high opportunity cost.

Other things being equal, there will be a net loss in welfare from restricting trade.
Due to this reason, any gain in government revenue or profits to firms would be
outweighed by a loss in consumers surplus.
ii. Restricting trade is unlikely to be a first-bed solution to the problem, since it
involves costs of side-effect.
iii. Restricting trade may have adverse world multiplier effects.
iv. Protection may encourage retaliation.
v. Protection may allow inefficient firms to remain inefficient.
vi. Restrictions may involve considerable bureaucracy and possibly even
corruption.
Different Methods of Trade Protection Policy Employed by Countries
The policy of protection can be employed through the use of various methods. A
few of these are as follows:
(1) Tariffs (custom duties): These are taxes on imports. These are usually ad-
valorem, i.e. these are levied as a percentage of the price of the import.
Other features of tariff are:
(a) Tariffs that are used to restrict imports will be most effective if demand is
elastic.
(b) Tariffs can also be used as a means of raising revenue. They will be more
effective if demand is inelastic.
(c) Tariffs can also be used to raise the price of imported goods to prevent
unfair competition for domestic producers.
SHAH ACADEMY 26
(2) Quotas: It implies fixing of a maximum limit on the quantity of a good that can
be imported.
(3) Exchange Controls: These include limits on the amount of foreign exchange
made available to the residents for effecting transactions with rest of the world.
(4) Import Licensing: Imports may be required to obtain prior permission from the
government in the form of a licence, which may state the quantity of a good that
can be imported.
(5) Embargoes: This is a measure used by the government to completely ban
certain imports or exports to certain countries.
(6) Export Taxes: These can be used to increase the price of exports when the
country has monopoly power in their supply.
(7) Subsidies: These can take two forms. One, subsidies can be given to domestic
goods to prevent competition from otherwise lower- priced imports. Two,
subsidies on exportable goods are expected to increase the competitiveness of
the subsidised exports in the international markets.
(8) Administrative Barriers: Regulations may be designed in such a way as to
target imports. Taxes may be exempted for local products or ingredients favouring
domestic production.
(9) Procurement Policies: This refers to government purchases to favour domestic
producers.
(10) Support for Investment: Domestic production and investments may be
encouraged through different measures like lower interest rates, export credit
facilities and import credit facilities, etc.
The General Agreement on Tariffs and Trade (GATT)
Introduction of GATT:
The General Agreement on Tariffs and Trade (GATT) has its origin in 1947 at a
conference in Genera where negotiations between some 23 nations resulted in an
extensive set of bilateral trade concession which were then extended to all
participants and incorporated in a General Agreement

SHAH ACADEMY 27
The General Agreement on Tariffs and Trade, known as the GATT, is one-third of
the Bretton Woods system that was created after World War II to ensure a stable
trade and economic world environment. The International Monetary Fund (IMF)
and World Bank are the other two bodies of the Bretton Woods system.
While often referred to as an international organization, the GATT had a defacto

role as an international organization before the creation of the World Trade
Organization (WTO). The WTO was established on January 1, 1995 by the Final
Act of the Uruguay Round of negotiations.
Objectives:
(a) Raising standard of living;

(b) Ensuring full employment and a large and steadily growing volume of real
income and effective demand;
(c) Developing the full use of the resources of the world and
(d) Expansion of production and international trade.
Thus the GATT aimed at fulfilling its objectives through the promotion of free and
multilateral trade. At present, altogether 132 countries including India are the
members of GATT.
History and Basic Information:
After World War II, the United Kingdom (UK) and the United States (US) submitted
proposals to the Economic and Social Council (ECOSOC) of the United Nations
regarding the establishment of an international trade body that was to be named
the International Trade Organization (ITO). That is, perhaps, why the GATT is often
referred to as a UN related body and its documents are sometimes mistakenly
referred to as UN documents.
ECOSOC convened a conference, the United Nations Conference on Trade and

Employment in 1946, to consider the UK and US proposals. A Preparatory
Committee drafted the ITO Charter and it was approved in 1948 at the conference

SHAH ACADEMY 28
in Havana, Cuba. The Charter is often referred to as the Havana Charter or the ITO
Charter.
The first round of trade negotiations took place while the Preparatory Committee
was still working on drafting the Charter because the participants were anxious to
begin the process of trade liberalization as soon as possible. Their results were
incorporated into the General Agreement, which was signed in 1947.
Since the original signatory nations expected the agreement to become part of
the more permanent ITO Charter, the text of the GATT contains very little
institutional structure. This lack of detail within the agreement has created
increasing difficulties as the GATT membership and rules governing trade between
so many of the worlds nations have grown. The GATT has function as an
international organization for many years even though it has never been
formalized as such.
ECOSOC established an Interim Commission for the ITO that is referred to as ICITO.
Unfortunately, when time came for the members to ratify the ITO Charter, the
Congress of the United States refused and the ITO never became a reality.
The GATT survived, but remained intact only due to the Protocol of Provisional
Application of the General Agreement of Tariffs and Trade which was concluded in
1947 and which came into force in 1948.
The GATT completed 8 rounds of multilateral trade negotiations (MTNs). The

Uruguay Round (the 8th round) concluded with the signing of the Final Action
April 15, 1994, in Morocco and produced the World Trade Organization (WTO) and
it annexes.
The Basic Principles of the GATT:
1. Most-Favored-Nation (MFN) Treatment:
This is the fundamental principle of the GATT and it is not a coincidence that it
appears in Article 1 of the GATT 1947. It states that each contracting party to the
SHAH ACADEMY 29
GATT is required to provide to all other contracting parties the same conditions of
trade as the most favourable terms it extends to any one of them, i.e., each
contracting party is required to treat all contracting parties in the same way that it
treats its most-favoured nation.
2. Reciprocity:
GATT advocates the principles of rights and obligations. Each contracting party
has a right, e.g. access to markets of other trading partners on a MFN basis but
also an obligation to reciprocate with trade concessions on a MFN basis. In a way,
this is closely associated with the MFN principle.
3. Transparency:
Fundamental to a transparent system of trade is the need to harmonize the

system of import protection, so that barriers on trade can be reduced through the
process of negotiations. The GATT therefore, limited the use of quotas, except in
some specific sector such, as agriculture and advocated import regimes that are
based on tariff-only.
In addition, the GATT and now the WTO, required many notifications from
contracting parties on their agricultural and trade policies so that these can be
examined by other parties to ensure that they are GATT/WTO compatible.
4. Tariff Binding and Reduction:
When GATT was established, tariffs were the main form of trade protection and
negotiations in the early years focused primarily upon tariff binding and reduction.
The text of the 1947, GATT lays out the obligations on the contracting parties in
this regard.
The major defects of GATT are as follows:

SHAH ACADEMY 30
1. No Enforcement Authority: The GATT has attempted to prescribe an

international code of conduct in the sphere of trade. But there was no
enforcement authority to oversee the compliance of GATT regulations by
contracting parties and to settle their trade disputes.
2. Problems in the Formulation of General Rules: The members of GATT are

much diversify in nature, they had varied in economic and political motives and
they were also at different stages of development. These reasons created
difficulty in framing and implementing uniform general rules of conduct
concerning trade, tariffs and payment.
3. Less Benefits for the LDCs: The most of the members of GATT were in the
category of the LDCs. The GATT had provided less benefit to these countries. At
present, there are more restrictive trade arrangements in the world. The
Commodity-to-Commodity based app roach has proved to be detrimental to the
interests of LDCs.
4. Quantitative Trade Restrictions: The GATT had certainly ensured the sealing
down of tariff structure but the quantitative trade restrictions remained for a
long time outside the GATT ambit. Consequently, the developed countries had
used with impunity the quantitative trade restrictions such, as import quotas,
export subsidies, voluntary export restraints, health and safety regulation etc.
Uruguay Round Negotiations

Introduction : Uruguay Round Negotiations in 1995 and the resultant World Trade
Organization (WTO) that called for international trade between nations on equal
footings introduced many changes. Trade related to goods, services, people
(immigrant skilled labour) and capital was to be made more impartial so that
there is gradual reduction in the treatment for these factors of trade arising from
the host nation and from the imported country. Still there is lot of hiccups as far as
a mutual consensus is to be developed among various nations.

SHAH ACADEMY 31
The emerging economies are not ready to comply by the liberal definition of
intellectual property that they were forced to comply in the other WTO
negotiations at Geneva, Singapore and Seattle when the emerging economies
were not that organized like they have formed unions like brics, ibsa etc.
India being a signatory to world intellectual property organization convention is

pledged to gradually move towards a product patent regime from the present
process patent. It has initiated this process from 2000 itself. Moreover, India is
also making its own patents globally registered so it can reduce incidents like that
of basmati and turmeric.
Also an autonomous body under Sam Pitroda has been established namely
national knowledge commission that caters to compiling all inventions and
traditional knowledge that India has. This will reduce instances like plagiarism for
economic gains by the rich nations having financial muscle to fight protracted
legal wars.
India is also improving upon its regulatory framework as far as piracy is concerned
by bringing in constructive amendments in its Copyright Act of 1958.
Since the coming days there will be nations war for intellectual property as its
provides for massive economic gains so it is better that India takes these pro-
active steps so that it do not provide predators to take on all that had been in
practice in India since time immemorial. Also with realignment in its laws with the
international regime it tends to make itself a safe ground for international
products which fears their revenue loss from plagiarism.
(i) Agreement on Agriculture: The tariffs resulting from transformation of non-

tariff barriers, as well as other tariffs on agricultural products are to be reduced on
an average by 36 per cent in the case of developed countries over 6 years and 24
per cent in the case of developing countries over 10 years period.
The least developed countries need not make any commitment for reduction.

SHAH ACADEMY 32
(ii) Agreement on Trade in Textiles and Clothing: This provide for phasing out the
import quotas on textiles and clothing in force under the Multi-Fibre
Arrangements since 1974, over a span of 10 years, i.e., by the end of the transition
period on January 1, 2005.
(iii) Agreement on Market Access: The member nations will cut tariff on industrial
and farm goods by an average of about 37 per cent.
(iv) Agreement on TRIMs: The agreement on Trade Related Investment Measures
(TRIMs) calls for introducing national treatment of foreign investments and
removal of quantitative restrictions. It identifies 5 investment measures which are
inconsistent with the GATT provisions on according national treatment and on
general elimination of qualitative restrictions.
These are measures which are imposed on the foreign investors such as the
obligation to use local inputs, to produce for exports as a condition, to obtain
imported goods as inputs, to balance foreign exchange outgo on importing inputs
with foreign exchange earnings through export, and not to export more than a
specified proportion of the local production.
(v) Agreements on TRIPs: Trade Related Intellectual Property Rights (TRIPs)
pertain to patents and copyrights. Whereas earlier on-process patents were
granted to food, medicines, drugs and chemical products, the TRIPs agreement
now provides for granting product patents also in all these areas. Protection will
be available for 20 years for patents and 50 years for copyrights.
(vi) Agreement on Services: For the first time, trade in services like banking,
insurance, travel, maritime transportation, mobility of labour, etc., has been
brought within the ambit of GATT. The GATS (General Agreement on Trade in
Services) provides a multilateral framework on principles and services which
should govern trade in services under conditions of transparency and progressive
liberalization.
(vii) Disputes Settlement Body: Settlement of disputes under GATT was a never
ending process. There was ample scope for procedural delays, objections could be
raised at each stage of the dispute settlement process, and penal reports could be
rejected by the offending party.

SHAH ACADEMY 33
The Disputes Settlement Body (DSB) set up under WTO seeks to plug these
loopholes and thus provides security and predictability to the multilateral trading
system. It has now been made mandatory to settle a dispute within 18 months.
The findings of the DSB will be final and binding.
WTO:
History : The birth of World Trade Organisation (WTO) on January 1, 1995 holds a
great promise for the entire world economy in respect of international trade. This
World Trade Organisation will administer the new global trade rules establishing
the rule of law in international Trade, which amounted to nearly five trillion
dollars last year for goods and services.
Peter Sutherland, the first Director General of WTO recently said, The WTO binds
nations in a global co-operative endeavour to raise incomes and create good jobs
through fair and open trade.
The latest issue of GATT/WTO News (January, 1995) observed that the new global
trade rules were achieved after seven years of negotiations among more than 120
countries and through the WTO agreements and market access commitments,
world income is expected to rise by over 500 billion dollar annually by the year
2005 and annual global trade growth will be as much as a quarter higher by the
same year than it would have been otherwise. It is also further estimated that
WTO agreements would add US $ 2800 billion to global income by 2015.
Main features of WTO are:

(i) It is a powerful international organisation to promote multi-lateral trade.
(ii) It has replaced the GATT set up.
(iii) It facilitates face trade by removing tariff and non-tariff barriers in
international trade.
(iv) WTO has finalised set of rules and regulations and has its legal statuswhich
are mutually designed by members.

SHAH ACADEMY 34
(v) Agreements reached by member countries are binding on all members of

WTO.
vi) It includes trade in goods, trade in services, and also protects intellectual
property rights, foreign investment for all members.
(vii) It is not a agent of United National unlike IMF and World Bank.
(viii) All members have equal voting rights (one country-one vote).
(ix) WTO has a large secretariat and also has a huge organisational set up.
Main objectives of WTO are:
(i) Basic aim of WTO is to implement the new world trade agreement.
(ii) To promote multi-lateral trade among many nations.
(iii) To promote free trade by removing all barriers.
(iv) To promote world trade benefitting all members.
(v) To remove all hurdles for developing in open world trading system to boost
economic growth in all member countries.
(vi) To protect the interest of developing countries in respect of international
trade.
(vii) To enhance competition among all members.
(viii) To increase level of production and productivity for raising the level of
employment.
(ix) To expand and utilise world economic resources in a most optimum manner.
(x) To improve the level of livings for the population of this globe and speed up
rate of economic developed among member countries.
(xi) To undertake special steps for initiating development of poorest nations of this
world.
Thus, WTO is among the most powerful and one of the most secretive
international bodies on earth. It is rapidly assuming the role of global government,
as 134 nation-states including USA have ceded to its vast authority and powers.
WTO also represents the ruls-based reginue of the policy of economic
globalization throughout this globe.
Role of WTO:

SHAH ACADEMY 35
Firstly, the WTO administers, through various councils and committees, the 28
agreements contained in the final act of the Uruguay Round, plus a number of
plurilateral agreements, including one government procurement.
Secondly, the WTO also oversees the implementation of the significant tariff cuts
(averaging 40 per cent) and reduction of non-tariff measures agreed to in the
trade negotiations.
Thirdly, the WTO is a watchdog of international trade, regularly examining the

trade regimes of individual members. In its various bodies, members flag
proposed or draft measures by others that can cause trade conflicts. Members are
also required to notify in detail various trade measures and statistics, which are
maintained by the WTO in a large data base.
Fourthly, the WTO provides several conciliation mechanisms for finding an

amicable solution to trade conflicts that can arise among members.
Fifthly, trade disputes that cannot be solved through bilateral talks are adjudicated
under the WTO Dispute Settlement Court. Panels of independent experts are
established to examine disputes in the light of WTO rules and provide rulings. This
tougher streamlined procedure ensures equal treatment for all trading partners
and encourages members to live up to their obligations.
Sixthly, the WTO is a management consultant for world trade. Its economists keep
a close watch on the pulse of the global economy and provide studies on the main
trade issues of the day. The secretariat assists developing countries in the
implementation of Uruguay Round results through a newly established
development division and strengthened technical co-operation and training
division.
Finally, the WTO will be a forum where countries continuously negotiate exchange
of trade barriers all over the world. And the WTO already has a substantial agenda
for further negotiations in many areas.

SHAH ACADEMY 36
At present, the WTO has been passing through trials, tribulations and challenges.
But the organisation has taken the stresses and strains it had to bear in its infancy
rather well. It has already begun to show promising signs of growing into a vibrant
body which is destined to play a vital role in future development of World trade
and economy.
The WTO presently offers a far more powerful mechanism in order to resolve
disputes over trade. Growing competition for markets among the member
countries is bound to give rise to frequent quarrels and disputes among the
trading partners. Thus a trade-dispute resolving mechanism is very much required
under the present situation. WTO is now charged with the responsibility to
provide such mechanism.
Dispute Settlement Mechanism of WTO:
The WTO presently offers a far more powerful mechanism in order to resolve
disputes over trade, arising out of growing competition for markets among the
members. Under the present situation facing frequent quarrels and disputes
among the trading partners a trade-dispute settlement mechanism is very much
required. WTO is now charged with the responsibility to provide such mechanism.
A recent report of WTO observed that developing countries are emerging more as
active users of the multilateral dispute-settlement mechanism than the developed
nations. Such a move has been noticed more so in the World Trade Organisation
than in the General Agreement on Tariffs and Trade.
On March 5, 1996, the Dispute Settlement Body (DSB) established two panels at
the request of Philippines and Costa Rica. The DSB decision raised the number of
active panels in WTO to four, with three of them involving developing country
complainants.
The first WTO dispute, which had been settled bilaterally, involved two developing
countries Singapore and Malaysia. An in-depth analysis shows that in contrast, the

SHAH ACADEMY 37
vast majority of dispute-settlement cases in GATT were between developed

countries.
Improvements in the WTO is dispute-settlement procedures over those of GATT

have facilitated the lodging of formal complaints for all members.
These improvements include:

(i) Near automaticity of establishment of panels and adoption of their reports, and
(ii) Precise deadlines for every step of the panel process.
At present the WTO is making an all-out effort to evolve a consensus on

controversial and key issues like inclusion of social clause on trade agenda. The
Director General of the Geneva-based WTO, Mr. Renato Ruggiero says that the
immediate challenge is to build a consensus on the subject of trade and labour
standards in order to avoid this becoming a divisive issue.
The new WTO agreement extends the amount of Government procurement

opened to international competition by 10 times compared to the earlier
agreement. However, it remains only a plurilateral agreement with limited
membership.
Issue in WTO:
Along with other developing countries, India has also been facing various critical
issues related to different provisions of World Trade Organisation (WTO). Being a
founder member of GATT and a present member of WTO, India has to negotiate
several related issues in the WTO meetings in future as to safeguard the national
interests of the economy.
(i) Quantitative Restrictions (QRs): As per the provision of WTO, India along with
other developing countries, has to remove all import quantitative restrictions.
Although India had entered into bilateral agreement with European Union,
Australia, Japan and New Zealand on the removal of QRs in phased manner but
lost its case on import QRs against USA as the WTO verdict gone in favour of USA.

SHAH ACADEMY 38
(ii) Developing Culture for Patent Registration: One peculiar tendency we observe
that Indian firms have not yet developed a culture for registering their products as
patents. It is observed that about 90 per cent of patents registered during the
period 1972-94 in India belonged to multinational companies operating in the
country and merely 10 per cent of those patents were registered by two Indian
Companies, i.e. BH.E.L and Bajaj group.
(iii) Safeguards under ATC: The Multi-Fibre Agreement (MFA) has been hindering the
pace of the growth of international trade in textiles as such MFA is a kind of
discriminatory piece of legislation. With the help of this MFA, the developed
countries are protecting their domestic textiles and clothing industries by
imposing quantitative restrictions on its import from developing countries. In this
connection, the Agreement on Textiles and Clothing (ATC) has been permitting
quantitative restrictions by imposing quotas only if there is either serious
damage or potential threat to the domestic industry
(iv) Services Sector, GATS and Indias View: Trade in services, as proposed by Arthur
Dunkel, is a potential area of trade for developing countries. Such trade in services
include technical and professional services, communications, non-merchandise
insurance, leasing and rental equipment, brokerage etc. Apart from transportation
and travel, there are some income generating services created out of movement
of labour and property income (royalties and licence fees related to intellectual
property rights).
(v) Improvement in Agricultural Exports: Liberalizing trade in agriculture on a non-

subsidized basis is an important as well as difficult issue for negotiation. In order
to increase the volume of farm exports, WTO should give adequate attention on it.
In order to fulfil its objective, India should change its strategy far radically for the
development of agriculture by raising the productivity of agriculture through
technological upgradation along with measures for land reforms and also for
optimum use of fertilizers and irrigation in order to ensure quality in its
agricultural products and its ready acceptability by developed countries.

SHAH ACADEMY 39
Functions of the WTO:
The WTO is meant to perform the following functions:

i. Administer through various councils and committees, the 29 agreements
contained in the final Act of the Uruguay round of world trade talks, plus a
number of plurilateral agreements, including those on government procurement;
ii. Oversee the implementation of the significant tariff cuts (average 40 per cent)
and reduction of non-tariff measures agreed to in the trade negotiations;
iii. Act as a watchdog of international trade by regularly examining the trade

regimes of individual members;
iv. Ensure that members notify in detail various trade measures and statistics,
which are to be maintained by the WTO in a large database;
v. Provide several conciliatory mechanisms for arriving at an amicable solution to

trade conflicts among members;
vi. Resolve trade disputes that cannot be solved through bilateral talks by
adjudication in the WTO dispute settlement court;
vii. Act as a management consultant for world trade by having its economists keep
a close watch-on the pulse of the global economy and provide inputs to WTO by
studies conducted on the main issues of the day; and
viii. Assist developing countries through its secretariat to implement the Uruguay
round agreements through a newly-established development division and a
technical co-operation and training division.
The WTO is, thus, a forum where countries continuously negotiate the exchange
of trade concessions and trade restrictions all over the world. The WTO has a
substantial agenda for further negotiations in many areas, notably certain services
sectors.

SHAH ACADEMY 40
Structure:
The WTO has nearly 153 members accounting for over 97% of world trade.
Around 30 others are negotiating membership. Decisions are made by the entire
membership. This is typically by consensus.
A majority vote is also possible but it has never been used in the WTO and was
extremely rare under the WTOs predecessor, GATT. The WTOs agreements have
been ratified in all members parliaments.
The WTOs top level decision-making body is the Ministerial Conferences which
meets at least once in every two years. Below this is the General Council (normally
ambassadors and heads of delegation in Geneva, but sometimes officials sent
from members capitals) which meets several times a year in the Geneva
headquarters. The General Council also meets as the Trade Policy Review Body
and the Disputes Settlement Body.
At the next level, the Goods Council, Services Council and Intellectual Property
(TRIPs) Council report to the General Council. Numerous specialized committees,
working groups and working parties deal with the individual agreements and
other areas such as, the environment, development, membership applications
and regional trade agreements.
WTO Agreements:
The WTOs rule and the agreements are the result of negotiations between the
members. The current sets were the outcome to the 1986-93 Uruguay Round
negotiations which included a major revision of the original General Agreement
on Tariffs and Trade (GATI).
(a) Goods: It all began with trade in goods. From 1947 to 1994, GATT was the
forum for negotiating lower customs duty rates and other trade barriers; the text
of the General Agreement spelt out important, rules, particularly non-

SHAH ACADEMY 41
discriminations since 1995, the updated GATT has become the WTO s umbrella
agreement for trade in goods.
It has annexes dealing with specific sectors such as, agriculture and textiles and
with specific issues such as, state trading, product standards, subsidies and action
taken against dumping.
(b) Services: Banks, insurance firms, telecommunication companies, tour

operators, hotel chains and transport companies looking to do business abroad
can now enjoy the same principles of free and fair that originally only applied to
trade in goods.
These principles appear in the new General Agreement on Trade in Services
(GATS). WTO members have also made individual commitments under GATS
stating which of their services sectors, they are willing to open for foreign
competition and how open those markets are.
(c) Intellectual Property: The WTOs intellectual property agreement amounts to

rules for trade and investment in ideas and creativity. The rules state how
copyrights, patents, trademarks, geographical names used to identify products,
industrial designs, integrated circuit layout designs and undisclosed information
such as trade secrets intellectual property should be protected when trade is
involved.
(d) Dispute Settlement: The WTOs procedure for resolving trade quarrels under
the Dispute Settlement Understanding is vital for enforcing the rules and
therefore, for ensuring that trade flows smoothly.
Countries bring disputes to the WTO if they think their rights under the
agreements are being infringed. Judgments by specially appointed independent
experts are based on interpretations of the agreements and individual countries
commitments.
The system encourages countries to settle their differences through consultation.

Failing that, they can follow a carefully mapped out, stage-by-stage procedure that
includes the possibility of the ruling by a panel of experts and the chance to
appeal the ruling on legal grounds.
SHAH ACADEMY 42
(e) Policy Review: The Trade Policy Review Mechanisms purpose is to improve
transparency, to create a greater understanding of the policies that countries are
adopting and to assess their impact. Many members also see the reviews as
constructive feedback on their policies.
All WTO members must undergo periodic scrutiny, each review containing reports
by the country concerned and the WTO Secretariat.
Indias Role in World Trade Organisation!

India has consistently taken the stand that the launch of any new round of talks
depends on a full convergence of views amongst the entire WTO membership on
the scope and framework for such negotiations. Our more urgent task is to resolve
the concerns of developing countries on implementation of the Uruguay Round
agreements.
(i) WTO Agreement and Agricultural Sector:
The major fear was found among India farmers who thought that they would be
only on the mercy of multinational corporations who control the distribution of
vital agricultural inputs, such as seeds, fertilizers, pesticides and insecticides.
Only a few farmers will benefit from the improved inputs of the multinationals.
Small farmers will become land less laborer in the course of time and agriculture
in India will no longer remain a source of livelihood for two-thirds of India s
population. It will only add to their staggering poverty.
(ii) Slashing Subsidies:
On the whole, India Agriculture a non-commercial activity will not attract

Agreement rule which are relevant for commercial production and trading
activities. As India is not an agricultural exporter, the controversy on its impact on
Indias agriculture will only be marginal. The real impact will be on Japanese and
South Korean farmers.

SHAH ACADEMY 43
(iii) Increase in Exports of Food Grains:
The prices of agricultural products in the developed countries would go up as a

result of slashing subsidies. As a result, our farmers will be benefited as getting
higher price of their product in the international market. This will stimulate Indias
exports particularly for rice to countries like Japan and South Korea.
(vi) Increase in Production:
It is felt that the prices of certain products in India would also go up due to import
of certain agriculture commodities to meet domestic shortage like oilseeds.
(v) Public Distribution Systems:
The Agreement does not interfere with the Public Distribution System. India will
continue to offer essential food supplies to the weaker sections of the society at
subsidized rates.
(vi) No Increase in Imports of Food Grains:
As per agreement, it is not expected to raise Indias imports of food grains. It is

stated in the treaty that the poor countries facing balance of payments problems
may continue to impose Tariff on the import of food grains.
India can avail of this provision and avoid imports of foodstuffs, thereby stay off
easy imports of food grains. It is doubtful that with nearly 100 percent tariff duty
on imports of food grains, 150 percent on processed foods and 300 percent on
edible oils, imports can hardly stain in the domestic markets.
(vii) Patents and Sui-Generis:
The government of India has clarified that the present policy of not patenting, the
seeds would continue. As regards Sui Generis system, it is expected that the
protection of the rights of breeders should ensure improved varieties of plant
breeds.

SHAH ACADEMY 44
The system is the basic research in seed and breed technology India. A critical
analysis of patents and Sui-generis shows that seed production, i.e., development
of new varieties, their multiplication and marketing which were largely under
Government sector in the past years are moving into the hands of private sector.
Latest bio-technological tools are now being deployed by the corporate in the
development of hybrid and synthetic seed and planting materials. India has the
potential to emerge as a major exporter of seeds in the world market.
(viii) Freedom to Use Seeds:
It is doubtful that only rich and big farmers would afford the use of brand seeds.
This, in turn will obviously widen the gap between the rich and the poor farmers.
It is again a baseless fear. Under WTO Agreement the farmers are free to exchange
their seeds with the other. They, therefore, need not necessarily buy seeds from
the open market.
(ix) Market Access:
Dunkel Draft will in no way injure the interest of Indian farming community.
Rather, it will stimulate Indias exports of food grains and encourage research in
the field of crop farming. The Draft does not interfere with any of our plans of
rural upliftment.
The Government is not contemplating any cut in subsidy offered to the framers.
Farmers have the full freedom of using a part of their output as seeds for the next
crop. They can also exchange their surplus produce mutually.
The treaty proposes guaranteed access to importers of at least 3 percent of the

market for each agricultural item. This has been termed as Minimum Compulsory
Access (MCA) in agricultural trade. A country may however get exemption from
this clause on the ground of its balance of payment problem.

SHAH ACADEMY 45

SHAH ACADEMY 46

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INTERNATIONAL BUSINESS ASMIT SHAH : 9824289094

Introduction : By internal or domestic trade are meant transactions taking place

Generally no country is self-sufficient. It has to depend upon other countries for

PREPARED BY : PRUTHVIRAJSINH N RATHOD 9662051243

Characteristics of International Trade:

PREPARED BY : PRUTHVIRAJSINH N RATHOD 9662051243

There is a need of international trade due to the following reasons:

Advantages of International Trade:

PREPARED BY : PRUTHVIRAJSINH N RATHOD 9662051243

(3) Enhanced Wealth: Increase in the exchangeable value of possessions, means

(4) Larger Output: Enlargement of worlds aggregate output.

(7) Better International Politics: International trade relations help in harmonising

(9) Advantageous Competition: Competition from foreign goods in the domestic

Disadvantages of International Trade:

PREPARED BY : PRUTHVIRAJSINH N RATHOD 9662051243

1. Exhaustion of Resources: When a country has larger and continuous exports,

3. Dumping: Dumping tactics resorted to by advanced countries may harm the

4. Diversification of Savings: A high propensity to import may cause reduction in

5. Declining Domestic Employment: Under foreign trade, when a country tends to

6. Over Interdependence: Foreign trade discourages self-sufficiency and self-

Differences between Internal Trade and International Trade:

PREPARED BY : PRUTHVIRAJSINH N RATHOD 9662051243

6. Heterogeneous World Markets:

The behaviour of international buyers in each case would, therefore, be different.

Theories of International trade:

The assumptions taken under this theory are as follows:

e. Before specialization, countrys resources are equally divided to produce each

2.Theory of Absolute Advantage:

This is shown in Table- 1:

PREPARED BY : PRUTHVIRAJSINH N RATHOD 9662051243

Without specialization, total production of countries was 39 tons, which becomes

3.Theory of Comparative Advantage:

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Thus, country X has absolute advantage in producing both the products. As

It shows that country X has comparative advantage in producing wine. Similarly,

Now, country X exchanges 14 units of wine with 14 units of wheat produced by

The situation of both the countries after trade is shown in Table-6:

4 .Heckscher-Ohlin Theorem of International Trade

In our model, thus, factor-price ratio Price of Labour/Price of Capital in country A

Since X is a labour-intensive product in country A, it will be cheaper than in B,

PREPARED BY : PRUTHVIRAJSINH N RATHOD 9662051243

In short, a capital-rich and capital-cheap country exports capital intensive

Thus, Ohlins theory concludes that:

iii. A capital-rich country specialises in labour-intensive goods and exports them. A

Thus, goods requiring plenty of capital will tend to be relatively cheaper in

2.Global Strategic Rivalry Theory:

successful incompeting in international markets and concluded that;

3.Porters Theory of National Competitive Advantage:

According to Porters Theory of National Competitive Advantage success in

PREPARED BY : PRUTHVIRAJSINH N RATHOD 9662051243

Foreign Trade Multiplier:

The foreign trade multiplier can be derived algebraically as follows:

PREPARED BY : PRUTHVIRAJSINH N RATHOD 9662051243

The national income identity in an open economy is

PREPARED BY : PRUTHVIRAJSINH N RATHOD 9662051243

The foreign trade multiplier is based on the following assumptions:

PREPARED BY : PRUTHVIRAJSINH N RATHOD 9662051243

9. Government expenditure is constant.

1. Exports and Investment not Independent:

3. Full Employment not Realistic:

4. Not Applicable to More than two Countries:

5. Neglects Trade Restrictions:

6. Neglects Monetary-Fiscal Measures: