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Friday, 6 May 2016

Understanding the basics of International Trade

We all know that our stuffs are from everywhere. Bangladesh, China, US, South Korea and the list goes on. But what does it tell about the global economy and who stands to benefit from this? Before I put forward my perspective to these gripping questions, let me illustrate what International Trade is with an example.

Image Courtesy: Investopedia

Let's say Country A is a world leader when it comes to exporting of defense products and services. Export is basically when a good or service is shipped to another country for sale or trade. Country A also imports a lot of goods (say shoes).Now, though country A can produce enough shoes on its own, it focuses on producing defense equipment that it is better at. Country A buys shoes from other countries because it can get these shoes cheaply from other countries.This is the advantage of international trade. It doesn't make sense to produce everything on your own if you can trade with other countries that have a comparative advantage.

The annual difference between a country's import and export is called net export. If the total worth of a country's export exceeds its total import,it is said to have trade surplus. If the reverse is true, it is said to have trade deficit. It may seem like exporting will make a country wealthy while importing will make it poor. After all, if we buy products from other countries, we are shipping jobs overseas. right?Well, it's not necessarily true.

Assume you have a choice to buy a dress which is made in India or in Nepal. Now because of lower wages in Nepal, the imported dress will cost you less.Say, you end up saving 500 rupees, now what do you do with that money? You may either invest this money or spend on some other products or services like going to a restaurant or for a game of cricket. This in turn creates job in those sectors.So, basically international trade reshuffle jobs, though the quality of these jobs may differ.

Trade between countries depend on demand for a country's goods, political stability, interest rates, but the most important factor is exchange rates. Exchange rate is basically how much your currency is worth when you trade it for other country's currency. Lets consider a scenario, assume 1 yuan (Chinese Currency) is equal to 10 rupees. If a Chinese tourist in India wants to buy a shirt that cost 3000 rupees, he needs to pay 300 yuan. Likewise if an Indian tourist in China wants to buy a cell phone which cost 900 yuan, he would have to pay 9000 rupees. Now lets think about what will happen when exchange rate goes up i.e 1 yuan now equivalent to 15 rupees. We say yuan is appreciated. Now to buy the same shirt, the Chinese tourist would just pay 200 yuan. Similarly, now the Indian tourist in china needs to pay 13500 rupees for the same phone. It works the same way with import and export. Once yuan appreciates, it gets cheaper for the Chinese consumers to import goods from other countries and its export to other countries become more expensive. This results in the rise of import and a fall in export.

Most currencies, like the rupee and the dollar have floating exchange rate that change based on supply and demands. If India buys goods from US , it exchanges rupees for dollars. This creates a demand for the dollar and the dollar appreciates. At the same time, rupee depreciates. There are a few countries that peg their currency to another currency. This is when the central bank wants to keep its currency value in a certain range. It buys or sells currencies to achieve that. The Chinese government was well known for buying US dollars to keep the Chinese currency depreciated. When US would buy goods from China, Yuan would appreciate, then the Chinese government would buy dollars which kept the exchange rate about the same. This kept the Chinese import cheap for the Americans.

Now a little information on who stands on top when it comes to exporting and importing. China is the largest exporter overall and US is the largest importer based on the World Trade Organisation. India is positioned at 20th when it comes to exporting but is positioned at 8th when it comes to importing.


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