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Foreign Trade Meaning, Definition, Importance, Components

Table of Content:-

  1. Meaning of Foreign Trade
  2. Definition of Foreign Trade
  3. Importance of Foreign Trade
  4. Components of Foreign Trade

Meaning of Foreign Trade

Trade means buying and selling commodities/articles for valuable consideration. For example, a shopkeeper sells the goods after receiving the monetary value of the goods. The payment may be either in currency de by exchange for other goods or items. Trade may be within the country and outside the country. International or Foreign trade is an exchange of capital, goods, and services across international borders or territories. In most countries, it represents a significant share of gross domestic product (GDP). While international trade has been present throughout much of history, its economic, social, and political importance has been on the rise in recent centuries.

Definition of Foreign Trade

According to Wasserman and Haltman – “International trade consists of transactions between different countries”.

According to Anatol Marad, “International trade is a trade between nations”.

All countries require goods and services to meet the needs and expectations 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 it needs. Therefore, to meet its demands, it has to buy from other countries what it cannot produce or can produce in insufficient quantities. Similarly, the company also exports its goods which it has in surplus quantities. In international trade, India buys and sells goods and services from other countries.

Generally, no country is self-sufficient. It has to depend on other countries to import goods that are either unavailable or insufficient in quantity domestically. Similarly, it can export goods, which are in excess quantity with it and are in high demand outside. International trade means the trading of goods or services between two or more countries.

For example, International trade refers to the exchange of goods and services between India and the United States of America (USA). India shall export goods or services to the USA, while the USA shall import these goods or services from India. Therefore, what is coming into the country is an ‘Import’ and what is going out of the country is an ‘Export’.

What is Foreign Trade?

International trade is in principle not different from domestic trade. The motivation and the behaviour of parties involved in a trade remain largely unchanged, regardless of whether a trade occurs across borders or within a single country. The primary distinction is that international trade is generally more expensive than domestic trade. This is mainly because of the extra cost involved in crossing the border. For example, Imposing tariffs on goods and services increases their total cost. In addition, delays at the border result in time-related expenses, further burdening businesses. Furthermore, disparities in language, legal systems and cultural differences between countries can lead to additional costs, as they require adaptation and compliance efforts.

Importance of Foreign Trade

The economic behaviour of a nation is not very different from that of a household or a business. A household or business produces those items which it can produce at maximum efficiency and expertise. Similarly, a nation also tends to specialise in the manufacturing of those items in which it enjoys an advantage in terms of required skills and resources.

Global trade is necessary because of the following reasons:

1) Large-Scale Production

Manufacturing particular products at a large scale gives rise to economies of scale. Manufacturing something on a very large scale brings down the cost of production and maximizes profits. For example, a single plant producing diesel locomotives may suffice for the needs of Indian railways. However, if it increases its scale, then it can cater to the demands of neighbouring countries as well.

2) Degree of Self-Sufficiency

No country in the world can exist under isolation without self-sufficiency. All countries must engage in international trade so that they may obtain those products which cannot be manufactured or can be produced at a very high price. For example, the Soviet Union used to import 2 to 3 per cent of its trade requirements whereas the USA imports around 5%.

3) Geographic Factors

Countries differ from each other according to the availability of production factors. The prevalent geographical conditions in a country make it a leader in one type of resource when compared to another country. For example, because of suitable conditions for the production of tea, India and Sri Lanka command close to 87% of the global tea market. Similarly, mica in India, Manganese in Russia, Oil in Saudi Arabia, etc., are some examples of economies which have a favourable allocation of a particular commodity in comparison to other nations. Such favourable allocation has given them an advantage in international trade.

4) Occupational Distribution

The population of a country and the kinds of occupation in which it is engaged also differentiate it from another country. For example, India is largely an agrarian economy in which the bulk of the population is engaged in the agricultural sector. England, on the other hand, is a country which specialises in the manufacturing sector as it has an abundance of capital resources and a shortage of land. Thus, based on specialisation, different countries employ their population in different occupations.

5) Means of Transportation

The raw materials used for production can fall into the following two types:

i) Natural raw materials such as sand, soil, etc., and

ii) Localised raw materials such as coal, iron ores, etc. These can further be classified into two different types:

a) Materials which can lose weight, e.g., sugarcane.

b) Materials which do not lose weight, e.g., steel, cloth, etc. Those industries which use raw materials that lose weight and involve large transportation are normally located near the source for minimising the loss of transit.

6) Compensating the Production

Different countries specialise in different skills and products. This creates the necessity for international trade so that the countries can compensate those items which are not produced by them. For example, India specializes in many agricultural commodities and does not produce oil corresponding to its requirements. On the other hand, Iran specialises in the production of oil which facilitates international trade between India and Iran.

Components of Foreign Trade

The main components of foreign trade can be explained as follows:

1) Investment Income

This relates to relationships between the residents and non-residents of an economy These are of two types:

i) Compensation and salaries paid to the employees who are non-resident workers and

ii) Receipts in the form of investment income and payments which are made for financial assets and liabilities of the country. The latter includes payments and receipts related to direct investment, reserve assets, portfolio investment, and other investments.

2) Portfolio Investments

In portfolio investments, the foreign investor holds less than 10% of the capital in the target firm. This type of investment is one in which the investor normally has no intent to influence the management of the local company.

3) Trade in Goods and Services

The information related to the trade of goods and services is trying to correspond to various elements related to expenses and imports that originate from a particular country This information is utilised for the compilation and evaluation of the balance of payments. Data on trade in goods is also collected in customer surveys but is not translated into the balance of payment information. On the other hand, data related to trade-in services are explicitly collected for the balance of payment information

4) Foreign Direct Investment

Foreign Direct Investment (FDI) is the investment in which a foreign investor owns 10% or more of the country in which the investment is being made. This limit of 10% is important because it allows the foreign investor to have a stake and control of management and affairs related to foreign investment enterprise. FDI leads to a relationship between the investor and the enterprise in hot initial and subsequent stages of investment.

5) Other Investment

This is the balance category which includes all kinds of financial dealings that age not under the purview of direct investment, portfolio investment or reserve assets. Other investments mostly include trade credits, loans, currency and deposits, and other versions of assets and liabilities.

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