Apr 9, 2020 in Economics

Role Trade between Countries and Its Effects on Households and Firms

According to Wagner, trade between countries is an old subject dating back to the 14th and 15th centuries. Commodities such as tea were shipped from China to the rest of the world and silk from Netherlands to other countries. Documentation of international trade, however, started later in the 18th and 19th century. The works of Adam Smith and David Ricardo have played an important role in explaining international trade. Adam Smith came up with the theory of absolute advantage. The theory states that countries with the ability to produce more quantities of a product than competitors with the same resources have an absolute advantage in producing that particular good or service.

Countries should, therefore, focus on the production of goods that they have an absolute advantage.  Ricardo, however, observed later that the trade between countries was driven by comparative advantage and not the absolute advantage. According to Ricardo, countries may have an absolute advantage on all goods over their competitors. His insight was that the country can still benefit from trade as a result of comparative advantage. A country can focus on producing the products that it has a lower opportunity cost than its competitors. Trade between countries plays a critical role that has widespread effects on the households and firms which are the primary units of most economic models. This paper will focus on the role of trade between countries and how it impacts on households and businesses.

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Comparative advantage forms the basis of trade between countries. The principal of comparative advantage pegs the benefits of trade between countries on the opportunity cost of production. In this case, countries that lack the absolute advantage in the production of any good can benefit from trade by focusing on the production of good that they have a small opportunity cost of production. Countries further benefit from trade through the reduction of trade barriers. Barriers include tariffs and quotas. Trade between countries has played significant roles that are evident from the 20th century. The full benefits of international trade have not been achieved, but relevant bodies have worked to ensure significant milestones are made in international trade.  

International trade plays an important role in enhancing domestic competitiveness. Countries focus on areas where they can efficiently employ their factors of production. Factors shift towards the most productive areas. The cost of inputs reduces significantly and the value added on the products increase. Foreign investments enable countries to acquire finance. Firms benefit from efficient production of goods and service. Households, on the other hand, gain through improved economic welfare. Nevertheless, trade affects domestic companies negatively. Some find ways of adjusting to the changes from the competitive foreign producers. However, those that face difficulty in adjusting to the changes lobby their respective countries to impose barriers. The households may face unemployment as a result of job cuts.  

Trade between countries opens commercial opportunities for domestic firms and investment from foreign companies. The avenues lead to development and poverty reduction in developing countries. Foreign investments play a critical role in the broadening of the productive base of a country through private sector development.  The overall benefit is the improved economic welfare of the households and firms. Another role of international trade is the diversification of production. Countries can acquire significant inputs that they could not previously produce. Inputs may be obtained cheaply from trading partners and aid in the production of new products. Firms can venture into new production areas that could not be possible in the absence of trade. For instance, India reduced taxes on imports in the early 90’s, a move that encouraged manufacturers to import intermediate and capital goods from other countries. The country achieved significant growth in the manufacture of products with a 25% increase in manufactured exports.

Foreign direct investment is part of international trade. It plays a significant role in the transfer of knowledge and technology. Countries that are technologically advanced transfer information to those that are worse off through investments. As a result, trade boosts innovation and emergence of new production possibilities in the importing countries. Domestic firms gain through increased efficiency in production through technology. Technology aids companies to invest in new areas of production due to innovation hence opening new possibilities. However, the benefits of the foreign direct investment may not have any impact on the local economy if the host nation is unable to take advantage of the technological and know-how transfers. 

Countries employ various strategies to ensure openness in trading. Countries reduce barriers to trade and provide ease of doing business. The plans open new markets for the local firms in foreign countries. The companies export their products freely to new markets. The expansion of the markets leads to increased revenues for the firms as well as growth opportunities. The businesses benefit from the new markets as a result of international trade in that they get an extended market potential for their existing products. The trade between countries ensures that firms reduce dependence on the local markets. Domestic firms can gain shares in the global markets where they can depend on during seasonal fluctuations in the local markets.  Trade plays a major role in expansion of choices for the households. International trade avails a variety of products that consumers can choose. The process of commerce leads to an increase in supply which lowers prices. The products are of higher quality and are offered at competitive prices. International trade plays a critical role in the improvement of quality and the environment in general. Trade partners have the exchange best practices in various industries through capacity building. The firms benefit from the practice in different ways. First, the companies produce quality products that can compete in international markets. Secondly, the companies benefit through capacity building. The households benefit through the improved quality of goods.    

When firms and countries engage in international trade, they focus on areas that they can perform better. This encourages investment in areas that create stability. Investment in these areas can be made by the firms or foreign investors. The investment leads to the creation of employment opportunities with high incomes that lead to improvement of economic standards of households. Studies have revealed that firms that are open to international trade offer higher incomes to their employees than those that do not participate in cross-border trade. However, employment opportunities created by foreign companies can sometimes fail to offset the loss of employment by the local companies.

In conclusion, international trade is based on the theory of comparative advantage which ensures that countries benefit from the trade of products that they have lower opportunity costs than their competitors. International trade plays various roles in the development of the trading partners. The firms and households reap significant benefits from the trade. The firms enjoy increased market access as well as the adoption of new technologies among other benefits. On the other hand, companies benefit from employment opportunities and improved economic welfare. There exist some drawbacks to international trade. However, the effects are insignificant in the actual business. The full benefits of international trade can be achieved in a scenario where barriers to trade do not exist.

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