Free trade is international trade that takes place without any barriers such as tariffs, quotas, or subsidies.
A tariff is a duty (tax) that is placed upon import to protect domestic industries from foreign competition and to raise revenue for the government.
A quota is an import barrier that sets upper limits on the quantity or value of imports that may be imported into a country.
A subsidy is an amount of money paid by the government to a firm, per unit of output, to encourage output and to give the firms an advantage over foreign competitors.
A Voluntary Export Restraint (VER) is a voluntary agreement between an exporting country and an importing country that limits the volume of trade in a particular product (or products).
The Infant Industry argument proposes that new industries should be protected from foreign competition until they are large enough to compete in international markets.
Dumping is the selling of a good in another country at a price below its unit cost of production.
Anti-dumping is legislation to protect an economy against the imports of a good at a price below its unit cost of production.
A free trade area (FTA) exists when an agreement is made between countries, where the countries agree to trade freely among the members of the group, but are able to trade with countries outside the free trade area in whatever ways they wish, for example, the North American Free Trade Agreement between the United States, Canada, and Mexico.
A customs union is an agreement made between countries, where the countries agree to trade freely among themselves, and they also agree to adopt common external barriers against any country attempting to import into the customs union, for example, the Switzerland-Liechtenstein customs union.
Trade creation occurs when the entry of a country into a trading bloc leads to the production of a good moving from a high cost producer to a low cost producer. if, for example, a country joins the EU, its car producers are no longer subject to the EU common external tariff and it can export more cars to EU member countries.
Trade diversion occurs when the entry of a country into a customs union leads to the production of a good moving from a low cost producer to a high cost producer. When the United Kingdom, for example, joined the EU it had to impose a common external tariff on butter from the low cost producer New Zealand, and start to import butter from high cost EU producers.
The World Trade Organization (WTO) is an international body that sets the rules for global trading and resolves disputes between its member countries. It also hosts negotiations concerning the reduction of trade barriers between its member nations.
The balance of payments accounts measure the international trade performance of an economy and show how well it is managing to match imports and exports of goods and services and the flows of investment in and out of the country.
The current account records imports and exports of goods (sometimes known as the ‘balance of trade’ or ‘visible trade’) and imports and exports of services (sometimes known as ‘invisible trade’).
The capital account of the balance of payments records the flows of money into and out of a country for investment and other purposes. There will be inflows of money (credits) and outflows of money from a country (debits).
The capital account breaks down into a number of sub-sections:
(i) Direct and portfolio investment – direct investment is productive investment. In other words it is investment in plant, equipment, machinery or factories – investment that will help with the process of wealth creation. Portfolio investment on the other hand is investment in paper assets like shares. There may be both inflows and outflows of portfolio investment.
(ii) Other financial flows – this heading can cover a range of short-term monetary flows like bank deposits from overseas residents, loans into a country from abroad and so on. These short-term flows often arise to take advantage of changes in interest rates between countries and are sometimes called ‘hot-money flows’. These flows are often of a purely speculative nature.
(iii) Flows to and from reserves – all countries hold reserves of foreign currency and this section measures any changes in these reserves. If the government were trying to influence the exchange rate, e.g. trying to create an appreciation in the rate, then they may sell some of their foreign currency reserves and buy their own currency instead.
A capital account deficit exists where the revenue from the export of goods and services and income flows is greater than the expenditure on the import of goods and services and income flows over a given time period.
A current account deficit exists where revenue from the export of goods and services and income flows is less than the expenditure on the import of goods and services and income flows over a given time period.
An exchange rate is the price of one currency expressed in terms of another.
A fixed exchange rate is an exchange rate system where one currency is fixed in value against another. It involves the government working to keep the parity via intervention on the currency markets. These give certainty but can cost vast sums of foreign exchange from national reserves.
A floating exchange rate is an exchange rate which accepts that market forces will determine rates based on how they view a country’s trade performance and its economic and political stability. These systems cost less to maintain but can result in vast swings and changes in currency values. This can seriously affect trade performance and confidence.
A managed exchange rate is where the rate is floating but between upper and lower limits that the domestic government keeps it to. It brings more stability but at less cost to the national reserves.
A depreciation is a fall in the value of one currency in terms of another currency in a floating exchange rate system.
An appreciation is an increase in the value of one currency in terms of another currency in a floating exchange rate system.
A devaluation is a decrease in the value of a currency in a fixed exchange system.
A revaluation is an increase in the value of one currency in a fixed exchange system.
Deteriorating terms of trade exist where the average price of exports falls relative to the average price of imports.
Elasticity of demand for exports is a measure of the responsiveness of the quantity demanded of exports when there is a change in the relative price of exports.
Elasticity of demand for imports is a measure of the responsiveness of the quantity demanded of imports when there is a change in the relative price of imports.
