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Published by Enhelion, 2019-11-30 00:41:42

Module 7

Module 7



There have been multiple definitions of trade, a term sought to be defined by a multitude of
scholars, economists, academicians etc. in order to encompass within this definition its
inclusivity. Perhaps the simplest definition of trade is that it is the “buying and selling or the
exchange of goods and services”. However, as the concept has developed the definition has
changed to help maintain its inclusiveness.

The exact time bar as to when trading activities came into being dates back to 2500 BC,
when trade by sea flourished in Northern Mesopotamia. The Greek empire made a great deal
of profit from the exchange of olive oil and wine for metal and grain. Many facets of modern
commerce developed during this time period which formed the basis of what we have today.
However, during that period trade was mainly done by enhancing the process of commodity
exchange, adding new features to it as and when suitable. The concept of currency as a
measure of exchange came about much later. Until this time, the trading activity was mainly
done to satisfy wants. Commodities were exchanged to satisfy reciprocal wants thus being a
mutually satisfying activity. In fact, trade had become such a popular activity that merchants
and traders began expeditions to lands far away from their home terrain in order to trade. This
also led to not only the discovery of nations as we know of them today but to the capturing of
a number of colonies. One of the prime examples of this is the discovery of America in 1492
and that of the sea routes to India in 1498. Europe was regarded as the centre of trade as
goods such as sugar, tobacco, coffee and food as well as luxury products were easily
available. The capturing of colonies as well as the rise in economic power associated with
trade was soon realised. This was perhaps the main motivation behind trading activity
performed by nation states in that time. The increase in economic power of some states and
specially that of Europe gave rise to the era of colonization ultimately resulting in the
Industrial Revolution in 1750 which laid down stringent guidelines for trading activities.

Britain emerged as a dominant colonial power professing the free trade philosophy as being
the most beneficial to trade. The two World Wars saw massive destruction of the global
economic structure and a strong need was the establishment of a new international trade
regime. The conglomeration of several conferences, conventions and treaties at this time
helped to unify a global strategy to bring about world peace and to provide a common ground
for the development of all nation states. Nation states were not all backed by the same
economic power. Some were less powerful due to years of colonization or other facts as
compared to others. The super powers such as USA, Britain etc. had a dominant role in the
world and trade was no exception. The advantages associated and realised with the practise of
trade was no secret then and neither is it now. Economic stability, gain of power and the
wealth associated with the generation of trade were just a few of the benefits that accrued.
Very often trade relations help to maintain and even strengthen economic relations between
nation states. The need of the hour then was to create a platform wherein nation states can
trade. There was a need to bridge the gap between the free trade economies and the nations
that advocated protectionism. This ultimately led to the setting up of the Havana Charter,
which embodied the setting up of the International Trade Organisation. However, due to USA
denying ratification of this charter, the ITO never saw the light of day. To create a temporary
framework, till a more permanent solution came about, the General Agreement on Tariffs and
Trade, or the GATT in 1948 was instituted. This temporary solution lasted about 48 years
when ultimately the Uruguay Round culminated in the establishment of the World Trade

International trade has thus played a major role in shaping world history. The main advantage
realised from this activity is that it enables manufacturers and distributors to indulge in the
buying and selling of goods in another country. The difference of production of various
commodities between states helps to bridge the gap between production levels and realise the
cost advantages, ultimately leading to the realisation of wealth. The acquisition of goods and
services raises economic growth and enables nations to learn and mutually help each other.
Employment and income is generated all adding to the wealth of the country.

This module seeks to highlight the various aspects in terms of the characteristics, concepts
and the theories of trade.


The activity of trade can take many forms. The basic classification divides it into domestic
trade and foreign or international trade. The primary basis of such difference lies in the
geographical terrain where such an activity takes place. Trade within the territorial
boundaries of a nation state is known as domestic trade or internal trade or home trade. Trade
beyond the boundaries of a nation’s geographical terrain relates to international trade.
Internal trade is further divided into wholesale trade and retail trade. The former refers to the
buying in bulk or large quantities from the manufacturers or producers of these products and
selling them to the consumers interested in these products. Thus the chain of trade is linked
by the wholesaler who occupies an important position and is an intermediary between the
producer and the retailer. Retail trade, contrary to wholesale, involves buying in smaller
quantities. Usually for personal use this type of trade is usually the last link of internal trade
as retailers have direct contact with the consumers.

International trade is divided into export, import and entre-port. Import refers to the
purchasing of goods and services from a producer or manufacturer placed in another country.
The benefits of imports are multiple. They provide a range of choices to consumers having a
direct effect on the increase of the standard of living of the consumers of a nation. One of the
main benefits of imports is that it helps to fill the lacuna, if any, in the home country by
enabling the consumers to enjoy products of another. An imported product from one country
is an exported product of another. Export is the economic activity of trade involving the
selling of goods or services from one country to another. The benefits of exports are the
effect it has on the economic wealth of a country. When goods are imported for the purposes
of export, it is known as Entrepot trade. To strike a balance between imports and exports is
the main aim of a nation. All these three categories are dependent on government policies,
laws and legislations. On the international front, if the nation state is a member of the WTO,
the rules and regulations of the WTO would govern this process. However, even within a
country, laws and legislations are made to ease the process of internal trade. In India for
example, the Foreign Trade (Development & Regulation) Act, 1992 and the rules and orders
issued therein seek to regulate international trade. Payments for import and export
transactions are governed by Foreign Exchange Management Act, 1999. The Customs Act,
1962 governs the movement of goods and services through various modes of transportation.

(Such as rail, airways, roadways and sea ways or multi-modal forms) The Exports (Quality
control & inspection) Act, 1963 is another piece of legislation that seeks to help maintain a
level of exportation. Further, Export-Import (EXIM) policies are adopted and/or amended at
periodic durations to help maintain a rough framework and set goals and rules and

The difference between Internal and International trade is further classified into various heads
transcending geographical barrier difference. Inland trade assumes that the buyers and sellers
are of the same nation state. A foreign national, within the geographical country acting as a
buyer or seller partakes in internal trade as well. International trade usually involves sellers
and buyers of a different nationality. Since currency valuation is different across different
countries, international trade concerns itself with trade carried out in different currencies with
ranging valuations. This usually leads to good being more expensive or less expensive in a
particular country. The differences of currency valuation is a major contributor towards
wealth generation. In developed countries, the currency valuation is far more than developing
and least developed countries. This differences in currency is one of the major factors that
contribute towards making an export import decision. Since international trade concerns itself
with different nation states each having their own rules and regulations and sometimes even
trade restrictions, this process becomes more complex. Internal trade has a simpler regime as
it has to pertain to domestic law. This makes the process far easier and simpler with fewer
complexities. International trade is not only affected by the legal systems of nations trading
with each other, but also by the global scheme of trade which involves regulations made by
treaties, laws and international government bodies. Many a time two or more nation states
may formulate agreements relating to trade to help simplify this process. A major example of
this is NAFTA, an agreement for free trade between Canada, Mexico and USA that came into
being in 1994. Such agreements also have a direct bearing on international trade. Thus
domestic or internal trade is a simpler process as compared to that of the international trading
regime which has far more players. The latter also involves a number of parties which may
act as middle men who help render services to make this a smooth flowing process. Multiple
firms have come across to ensure that international trade flows smoothly. These can be
formal or informal associations that help ease the risk factor associated with this economic
process. An example of this is the institution of P&I Clubs that were formed to provide
insurance to wayfarers undertaking the sea route for trading activities. They are associations
formed by those who act as both the insurer and assured/insured by paying a sum towards the

cause in accordance to the club’s rules. These clubs are an example of associations and guilds
formed to minimise the risk element which is pertinent in international trade. Despite the risk
factor and it being a more complex process, international trade has several benefits associated
with it. It is perhaps in the efforts to realise these advantages that form the driving forces for
nations to perform trading activities. A detailed analysis of the advantages of international
trade will be discussed in the following section.


It is an established fact that no nation can survive on its own. In order to realise a nation’s
true value and potential it requires the aid of other nations to be part of the trading network.
Isolation and self-sufficiency are fond myths which do not exist in reality. Therefore, for a
nation to truly benefit out of trade it has to be co-dependent. Nations that have a strong hold
on economic power are seen to be the strong actors in the international trading regime as well
as establishing a direct link between development and international trade.

International trade has several advantages. The presence of a market place of another nation
often acts as a threat to the domestic market due to the increased competition. This in turn
makes the producers in the home market want to produce products and services of a better
quality so as to beat their international competitors. The increased competitiveness not only
reduces prices but also increases buying options for consumers therefore resulting in a
simultaneous increase in the lifestyle of consumers. Products that are seasonal in one nation
can be imported in the unseasonal time which helps to stabilize the fluctuations caused due to
changes in seasonal factors. Products which otherwise would not even have been known
about, let alone available, are easily accessible.

The export-import regime helps domestic firms to expand their business, thereby gaining the
benefits from economies of scale. Another major advantage of international trade relates to
technology and innovation. Innovation is the discovery of a new invention and its industrial
use. The rate at which technology develops is rapid. Trade contributes in spreading the use of
new and effective innovations throughout the world. This in turn leads to cost efficient
production which reduces the cost associated with manufacturing and production. This
growth aspect has risen over eighty percent in the last twenty-five years in the US. In fact,
growth and expansion aren’t lone factors. Growth in the trade industry benefits the
unemployed by the generation of both unskilled and skilled job profiles. Small and mid-level
firms reap the benefits arising out of this growth as the economy requires more production

thereby increasing opportunities. In the case of USA, exports of manufactured goods directly
support more than six million jobs. Nearly one third of US merchandise exports are by these
small and mid-level firms.

The need to strike a balance between the trading regime of import and export is perhaps one
of the major struggles of a nation state. This has led to the formulation of various trade
theories and principles.


Uruk, in southern Mesopotamia is regarded to have being the starting point of the trading
regime. It was this city that gave to the world patterns of trade and a well-established trading
network that lasted centuries. The trading patterns of nations are a common subject of debate.
To establish a pattern of trade and explain the mechanisms of this economic process, trade
theories were brought to light. Divided into classical and modern theories, these were
developed in order to establish a sense of predictability to an otherwise complex and
unpredictable sphere. The classical trade theories, developed before the twentieth century are
from the perspective of a country as compared to modern theories that are from the
perspective of the firm. The shift in the outlook is in coherence with the economic shift that
took place in the mid twentieth century that gave rise to the modern theory. Both these
classifications of theories have sub sets. The classical theory consists of Mercantilism, the
Heckscher-Ohlin theory, Absolute Advantage theory and the Comparative Advantage theory.
The Modern theory comprises of Country Similarity, Product Life Cycle, Global Strategic
Rivalry and Porter’s National Comparative Advantage.

Mercantilism was one of the first attempts to develop an economic theory as early as the
sixteenth century. The presumption at that time was a country’s wealth was measured in the
amount of its gold and silver holdings. Therefore, in order to increase these holdings, trade
should be done by promoting exports and minimising imports. The primary stance was the
increase in the surplus of trade. This theory is regarded as being selfish. This is so as it is
based on the premise that one nation’s loss is another nation’s gain. World history is
indicative to the successful implementation and adaptation of this theory as during that time,
rulers and kings measured their power in accordance to the factors such as the capture of
states, increase in wealth and stronger armies. More gold and silver along with other riches
led to more economic power which is what this theory proposes. Though ancient, traces of
this can be seen in modern day economies such as that of Japan, China and even Germany

that favour exports and discourage imports by promoting protectionist policies and increasing
domestic subsidies. Critiques of this theory are those that follow the ideals of free trade.
Protectionism and free trade will be discussed in detail in the next segment.

Adam Smith, a critique of the theory of mercantilism, gave to the world the Absolute
Advantage Theory in his book ‘The Wealth of Nations- An Inquiry into the Nature and
Causes of the Wealth of Nations’ in 1776. This theory focused on the ability of a country to
produce a product with greater efficiency than another nation. Trade should be done by
taking into consideration what can be produced at ease in one country may not be produced
with equal ease in another. Therefore, exports should comprise of all those goods and
services that are produced at ease in the nation and imports should comprise of those that are
difficult to produce. This process should take place according to the free flow of the market
forces. Gold and silver therefore are disregarded as the nation’s wealth,the focus should be on
market forces that directly affect the people instead.

Comparative Advantage, a challenge to this theory, proponed by David Ricardo focused on
the possibility that a country may have an advantage at producing more than one good whilst
another may not have the advantage at producing any good. Therefore, the exchange then
should be in accordance to the cost of production and factors of production. Relative
productivity is the focus of comparative advantage as compared to absolute advantage that
focuses on absolute productivity. The benefits of production are the gains from trade. This
principle highlights the opportunity cost of production. This theory however was also based
on the free trade principle.

In the early 1900’s, Swedish economists Heckscher and Bertil Ohlin sought to bridge the
disparities of the theories of absolute and comparative advantage. They focused on the factors
of production namely land labour and capital and the utilization of these factors by a nation
state. This theory also called the Factor Proportions Theory, that stated that those goods and
services should be exported which could be produced by cheaper production by factors that
were supplied at a greater ease. Imports should comprise of goods and services that would
require resources that were in short supply but the demand of which was high. However, in
the early 1950’s, Wassily W. Leontif, a Russian born American economist, gave to the world
the Leontief Paradox. In his study of the US economy, it was found that though US was
abundant in capital as compared to labour, more labour intensive goods were exported.

As the world witnessed devastating tragedy during World Wars I-II, a paradigm shift took
place in the nature of trade. This shift saw the emergence of economic trade theories that
focused more on the outlook of firms. This was mainly due to the growth of multi national
corporations and trade in those goods and commodities that existed between countries that
produced goods in the same industry.

Modern theories encompass brand and customer loyalty, technology flow and development,
quality and product and service factor.

It was noted that countries are of different types-developing, least developed and developed
countries. This transition cycle warranted different wants of different types and requirements
thereof differed. Steffan Linder developed the country similarity theory by noting that
consumers in countries that are in the similar cycle of development have similar preferences.
Firms therefore, adhere to their domestic market trends first and expect the same trend in a
similar market of a different nation state. The more similar these markets are, the more
success would naturally be expected. Therefore, trade of manufactured goods would be more
successful in nations wherein the income levels and capita levels are similar.

However, as noted by Raymond Vermon, products too undergo a life cycle that affects trade.
Pertaining mainly to the marketing of a product, he established that a product has three
stages-that of a new product, maturing product and a standardized product. The production of
a new product would occur in the home country of its innovation. The most glaring example
of this is the development of the personal computer that gained maturity in the 1980s-1990s.
Having attainted its standardized stage, the majority of manufacturing and production is
outsourced. However, this theory falls short in explaining how countries innovate and
manufacture across the world.

Barriers to entry are one of the main obstacles to trade. They can be divided into tariff and
non-tariff barriers. The Global Strategic Rivalry theory based on the work of Paul Krugman
and Kelvin Lancaster focused on MNC’s and their effort to strengthen the barriers to trade so
as to gain advantage. This was a move towards protectionism and was critiqued for being
contrary to the world trading regime.

The capacity of a firm to innovate and upgrade primarily in the usage of the local market
resources, the demand of local market and its conditions, the local suppliers and the local
firm characteristics are regarded as explanation given to the industry specific competitiveness
in certain industries in a nation as compared to the other. Porter’s theory of National

Competitive Advantage took into account the role of the government as well that has a direct
impact on the trading activities.

Therefore, as seen, these trade theories embody the principles of trade which are broadly the
protectionist and free trade theory. The next section seeks to explain them in detail.


There are two underlying philosophies or principles of trade: Free Trade and Protectionism.
The era of mercantilism saw the spread of protectionism tendencies where as Adam Smith
and Ricardo advocated Free trade. The fundamental and simplest difference between the two
is that one seeks to impose barriers of trade and the other doesn’t. Protectionism seeks to
protect the nation’s domestic market from the threats of foreign trade. This is done mainly to
protect home industries from foreign competition. Protectionism also helps build up new
industries and is meant as a safeguard. Every country at some point or the other has
implemented protectionist strategies. An example of this is the notorious Smoot Hawley
Tariff Act,1930 passed by the United States Congress which raised tariffs on imported goods.
What seemed to be a protectionist measure, led to the downfall of the US economy resulted
in a massive downfall of imports. The advocates of free trade condemn protectionist
measures and project that in order to realise the true benefits of trade, protectionism should be
kept to a bare minimum or negated completely. Free trade increases the size of the economy
as a whole whilst offering multiple benefits to the consumers ranging from choice of goods to
reducing the cost of trading which in turn reduces costs. The international organisation
concerning itself with trade, the WTO, strives to strike a balance between these philosophies
that the developed countries advocate-free trade, whilst developing and least developed
countries tend to implement protectionist measures to protect their domestic markets from
foreign competition. In the latter categories of countries, such measures are sometimes
needed das these nations are not ready to face competition from foreign markets. Such
competition might lead to the destruction of the markets of developing and least developing
nations which is a risk that such nations cannot afford. Therefore, protectionist strategies are
followed. The free trade versus protectionism debate is one which is never ending. There is
no concrete proof as to which regime is better and what works best. However, one of the
major factors that contribute towards the usefulness of these strategies is in accordance to the
nation’s economy of where it is implemented.

The succeeding chapters will aim to give more insight into these aspects of trade along with
the present day scenario.


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