Basis Of Foreign Trade And The Advantages And Disadvantages Of International Trade

The article explains the advantages and the disadvantages of foreign trade. It explains the salient of the international trade. What is the basis of international and foreign trade? Why is foreign trade important? What is the necessity of foreign trade? What are the documents required in export and import of goods? What permissions and licences are required for export and import? What are the types of price quotation used in foreign trade? These are answered by this article.

Characteristics of international trade

  • Territorial specialization: International trade among the countries is possible only because each country has certain resources that can be well utilized for the production of certain type of commodity that is not available in other countries or available in very less quantities.Hence, each country has some sort off comparative cost advantage that means each country can produce a good at a lower price than the other country and hence, can export that.

  • International competition: Producers from different nations are always in a race with one another to sell their products in as much quantity as possible. Thus, advertisements, sales promotion activities are very helpful in these types of selling techniques.

  • Separation of sellers from buyers>: Each country is separated by a large geographical distance and hence, the buyers and the sellers are unable to meet each other physically. They contact each other through mass communication devices such as telephones, internet, video conferencing etc.

  • Long chain of middleman: Since the buyers and the sellers are unable to meet each other, they have to rely on long chain of middleman to complete their international transactions. It does increases the cost of the goods of the buyers and hence, the imported goods are much expensive.

  • Mutually acceptable currency: All the nations, except countries of Europe, have their own currencies and other modes of payment. Hence, it is not possible to have a common currency for exchange between nations. Thus, dollars, pounds are selected for this purpose and hence, they are called "hard currencies". These currencies are acceptable all over the world.

  • International rules and regulations: Each buyer and seller involved in the international trade have to complete the guidelines and norms set up the custom authorities of the others country. They have to follow the restrictions of that nation.

  • Government control: The government of every nation exercises effective control over the export and import trade of the nation. Hence, various types of formalities and documents have to be submitted to the government.

Basis of international or foreign trade

Foreign trade is based on the theory of comparative cost advantage.It states that every nation exercises certain kinds of benefits from the production of a particular type of commodity whose resources are exclusively available in that nation or available in other nations in very less amounts. For example, Iraq and the similar nations have comparative advantage over th production of crude oil. Hence, it can export it to other nations and earn huge profits. Similarly, India specializes in the production of sugarcane and tobacco. No country is self-sufficient and it has to depend on other nations to obtain the required inputs be it machines, labor, raw materials or even finished products.

Thus, the need for foreign trade arises due to the following factors:

  1. All nations of the world have to depend on the other nations as it cannot produce every things by itself in a lower cost.

  2. A country may get the resources and manpower to produce all types of commodities but it may be able to get that commodity at a cheaper rate from the other nation who specializes in the production of that commodity.

  3. Similarly, a country may produce some goods at a cheaper rate than the other nation and may try to export it to other nations at a higher rate if there is a surplus.

Difficulties in international trade

  • Distance: Due to long geographical distances between the nations, goods are either sent through rail, road or sea or air. All these modes of transport are expensive and may face the dangers of sea or air perils such as explosions or accidents etc. There may be a delay in the delivery of goods that may lead to the spoilage of certain perishable goods. Distance creates higher transport costs as well as more risks.

  • Different languages;Different languages are spoken in different nations. Hence, the buyers and the sellers may not be able to communicate with each other effectively. They may have to depend on the translators that are not always reliable.

  • Risk in transit: Foreign trade involves high risks than the home trade. Many of the risks can be covered by insurance but still, the danger persists.

  • Lack of information about foreign businessman: A seller is always worried about the credit-worthiness and the financial standing of the prospective buyer as there is no strong proof of the buyers ability to pay. Thus, there is the risk of bad debt for the seller.

  • Import and export restrictions: Every country charges a high rate of custom taxes and duties on the import of the goods. Also, businessman are required to fill various documents and formalities to complete the transactions. Foreign trade policies and procedures vary from nation to nation and also from time to time.

  • Study of foreign markets: Every foreign market have its own features. There is different price interactions, demand supply interactions, government policies, marketing methods, customs laws, weights etc. It is very difficult to collect all the information accurately about the foreign markets.

  • Problems in payments: Every country has its own currency and exchange rates with which the transactions can completed. These exchange rates keep on changing. Remittance of money in foreign trade involves much time and expense. There is also huge risks of bad debt.

  • Intense competition: There is a huge competition between the sellers of the different nations involved in exporting the same commodity. The one who succeeds in influencing the buyers from the advertisements and other incentives stands out as the winner of the market. Thus, heavy and useless expenses are incurred in these activities.

Advantages of foreign trade

  • Geographical specialization: Foreign trade permits every nation to produce those goods only that have all the advantages and facilities of being produced at a cheaper rate, thus ensuring full and optimum utilization of the resources such that the country earns maximum profits. It also helps in lowering the cost of production due to the various economies of scale.

  • Economic development: Foreign trade enables the nation to import manpower, technical assistance from developed nations and machines and other tools required for mass scale production to enable the economies of scale. A county can also earn valuable foreign exchange from the exports of the goods and the services and can utilize them for the economic ans social development.

  • Economies of scale: Foreign trade enables the nation to produce not only or the home consumption but also for the export. It enables the nation to reap the harvest of the large scale production in the form of economies of scale. It helps in lowering the cost of production.

  • Generation of employment: Foreign trade assist the development of the agriculture and industrial sectors. Expansion of these activities helps in the generation of new employment opportunities. Also, foreign trade requires long chain of middlemen, that generates employment also.

  • High standard of living: Due to the globalization, people have an access to the variety of products and services out of which the consumers select the best. Thus, exchange of goods and services between the nations increase the standard of living for the people.

  • Price equalization: Foreign trade helps in equalizing the prices of goods and services during boom and depression periods. When the prices of the goods tend to fall, the commodities are exported in large quantities so that the surplus can be removed from the nation and there is a balance between demand and supply. Similarly, when the prices of goods rises, the exports are reduced and the imports are increases to balance the demand and the supply.

  • Security from famine and drought conditions: When the supply of the good and necessities falls drastically, the country may ask for help to the other nation and the other nations may supply the necessary items such as the blankets, medicines, water, food, clothing etc. Foreign trade protects the nation from starvation.

  • International brotherhood: Through foreign trade, the cultures and the ideas of the nations are exchanges between each other. There is a mutual understanding between the nations that helps to promote the feeling of mutual understanding and brotherhood. It also develops healthy business conditions for both the nations and provide a sense of security to the people as neither of the nations will attack the other.

Disadvantages of foreign trade

  • Economic dependence: Too much dependent on the other nations in the form of increases imports may seriously affect the economic sovereignty of that nation and may result in the colonization of the nations that are economically and politically weaker.

  • Restricted growth of home industries: Foreign trade allows the full participation of the foreign industries that in most of the cases, are better in every respect. They sell high quality goods at a very low rate. As such, the domestic industries may face stiff competition from these industries and as a result, may be forced to shut down. This is what happened in India before independence when the domestic industries could not cope up with the textiles of Europe and many hand-made textile industries has to be closed down.

  • Misuse of natural resources: It may happen that the demands and the nature of demands vary too much from country to country. As such, the exporting industries may be interested to produce those goods only that are in high demand in other nations. As such, the may produce luxury items at the cost of basic necessities. As luxury goods do not have much market in a developing nation like India, it may affect the utilization of the natural resources.

  • Political exploitation: Foreign trade, as explained earlier may endanger the political stability and strength of a weaker and developing nation like India. The economic dependence may soon give advantages to developed nations and they may try to unnecessarily influence the political decisions of the country for their own benefit.

  • Import of harmful goods: Import of luxury goods, and spurious items such and drugs and other harmful chemicals may endanger the security and the safety of the common citizens.

  • Rivalry among nations: Intense competition may lead to rivalry among nations. They may fight for increasing their own sells and hence, may waste a lot of money on advertisements. Sometimes, increased instances of terrorism and other activities may result in the while and one country may suspect the rival nation for that, thus hampering international peace and security.

  • Invasion of culture: No doubt, the foreign trade result in the spreading of culture and traditions of one country. It may at the same time unduly influence the younger generation of the country and they may start imitating the styles and the lifestyle of the foreign countries.

Documents involved in international trade

  1. Indent

  2. Letter of credit

  3. Bill of entry

  4. Bill of sight

  5. Dock challan

  6. Bill of lading

  7. Mate's receipt

  8. Shipping order

  9. Shipping bill

  10. Insurance policy

  11. Consular invoice

  12. Certificate of origin

  13. Dock warrant

  14. Port trust dues receipt

Types of price quotations used in foreign trade

  • Loco price: It included the cost of goods plus a profit margin. The buyer has to incur the expenses till the arrival of goods in his warehouse.

  • F.O.R (Free on rail): The price includes the cost of goods, expenses of carrying them to the railway station and loading them in the wagon. All other charges are payable by the buyer.

  • FAS (Free alongside ship): The quotation included the cost of goods and all the expenses of carrying them to the side of the ship. It includes the cost of carrying through the rail but does not include the expenses of loading the goods on the ship.

  • CIF (Cost, insurance and freight): This quotation included the cost of goods, the freight charges and the insurance charges.

  • In Bond price: It includes all the expenses incurred in carrying the goods up to the warehouse of the importer at the port of destination.

Modes of payment in foreign trade

  • Open account: Under this method, the importer makes payment at periodic intervals directly to the exporter in settlement of account. The exporter sends periodic statement to the importer. There exists risk for the exporter in this method due to the absence of an intermediary between importer and exporter.

  • Direct remittance: In this method, the exporter sends both the goods and the ownership documents to the importer. The importer directly send the payment to the exporter by means of international money order tools such as mail transfer, Paypal site or foreign bank draft. The exporter can get immediate payment from the bank draft.

  • Documentary bill of exchange: A bill of exchange is an order given by the seller to the buyer to pay th specified amount on demand. Bill of exchange is a negotiable instrument. The exporter can use it to clear his own debts. The steps involved in the remittance of money through bill of exchange are:

    1. The exporter draws the bill of exchange on the importer and sends it to the importer.

    2. The exporter, prior to sending the bill hands over th bill to his bank along with shipping documents.

    3. The importer's bank presents the bill to the importer.

    4. The importer remits the payment to the exporter.

  • Documentary letter of credit: Under this method, the importer arranges with his bank to issue a letter of credit in favor of the exporter. A letter of credit authorizes a bank to pay the specified amount to the specified party on receipt of the specified documents.
    The steps involved in the remittance of money through letter of credit are:

    1. The importer asks his bank to issue a letter of credit to the exporter's bank certifying his credibility.

    2. The exporter submits the documents like shipping documents to the importer;s bank as his identity proof.

    3. The importer scrutinizes the documents. In case, the documents are in order, the bank debits the importers account and makes payment to the exporter's bank.

More articles: Foreign Trade


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