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Increased access to cheaper and more varied goods and services is a key benefit of international trade. Thus, it allows us to increase well-being. We can satisfy our needs and wants by buying more varied and cheaper products not produced domestically.
In addition, international trade also has an important impact on economic growth. The export market offers a significant market size for domestic companies. Thus, when their export demand increases, they produce more. They then increase the demand for domestic labor. As a result, more jobs and income are created in the economy.
In addition, international trade also brings more competition. Companies are forced to operate more efficiently to stay competitive. In the domestic market, they face imported products. Meanwhile, in the international market, they face companies from other countries.
Technology transfer is another benefit. Thus, international trade promotes not only short-term growth through increased exports but also long-term economic growth by increasing total factor productivity (TFP).
Why do countries trade?
International trade has existed since time immemorial and continues to increase in today’s modern economy. It allows a country to expand its market by selling products to foreign markets, which are wider than the domestic market. In addition, the country can access some goods and services that may not be available domestically.
What is international trade? It involves selling and buying goods and services across a country’s borders. A country sells domestically produced goods and services to overseas buyers. We call this export. As compensation, the country earns income, which represents the injection in a circular flow diagram and is circulated to produce more output.
Meanwhile, the country buys goods and services from other countries for domestic purposes. We call this an import. Not all goods needed and desired are produced domestically, so the country has to buy them from abroad.
Or, some goods may be more expensive domestically produced. Thus, importing becomes a reasonable alternative to get cheaper goods.
Exports and imports have increased in recent years. For example, World Bank data shows how exports have grown. It accounted for about 29.1% of the world’s GDP in 2021, increasing several times compared to 12.9% in 1970.
In addition, some countries are highly dependent on international trade to grow their economies. For example, Singapore’s exports accounted for over 184.8% of the country’s GDP in 2021. Likewise, Luxembourg, Hong Kong, Malta, and Ireland also reported shares above 100% in the year. As such, exports have played a significant role in these countries’ economic activity and performance.
What are the benefits of international trade?
Countries trade with each other because they derive essential benefits. Trading benefits include:
- Lower prices for consumers
- Greater choice for consumers
- Wider market size for the company
- Higher economies of scale
- More intense competition
- Greater efficiency in production
- Obtaining the required resources
- More efficient resource allocation
- Source of foreign exchange reserves
- Skills and technology transfer
- A key driver for economic growth
Lower prices for consumers
International trade encourages countries to specialize. For example, the domestic economy concentrates on one or a few goods and services produced efficiently. Thus, through specialization, the domestic economy can produce cheap specific products.
To obtain other goods, the domestic economy buys from abroad. And because they also specialize, other countries also produce products at lower costs.
Thus, when all countries specialize, international trade allows countries to obtain cheap products. They produce affordable output, selling to the domestic market and partly overseas. They then buy some products from global markets, which are made more frugal in other countries than domestically.
Greater choice for consumers
International trade allows us to access cheaper goods and a more varied choice. Some goods may not be produced domestically, so we cannot consume them without trading. However, we can get them from other countries by trading.
For example, we can’t get a computer or smartphone like Apple when we don’t trade. They are produced abroad. Thus, they are not available in the domestic market without importing them.
Wider market size for the company
Overseas markets offer significant growth opportunities. Their size is much greater than that of the domestic market. Thus, companies can access a broader market by trading with other countries.
There are several ways to access foreign markets. Some companies may prefer exports. Others may develop franchise networks like Starbucks and McDonald’s in many countries. Or, they build supply chain networks worldwide by establishing subsidiaries in several countries, as transnational companies do.
Higher economies of scale
Companies can achieve higher economies of scale when they can access a broader market. This is because the larger market encourages them to produce output on a larger scale. Thus, they can spread their high fixed costs over more output, enabling them to lower unit costs.
Finally, higher economies of scale allow firms to operate more efficiently. And they can sell the output at a lower price.
In contrast, without international trade, production is limited by the size of the domestic market. If the domestic market is small (due to a small population), firms do not benefit from higher economies of scale.
Increased competition
International trade brings more competition in the domestic market. When foreign products are imported, consumers have more choices. They can buy domestic products or imported products.
For consumers, this situation is advantageous. First, they have more choices when it comes to buying. Second, imports push market prices down. So, they get a lower price.
On the other hand, domestic producers face higher competitive pressures due to imports. They don’t just compete with other domestic competitors; they also have to compete with foreign players from imported products. As imports increase, they face more competitive pressure.
Greater efficiency in production
International trade encourages greater production efficiency. On the one hand, domestic players must improve their efficiency to compete effectively with imported products. They must produce at the lowest possible cost.
Consumers will switch to imported products if they fail because they are cheaper. As a result, domestic companies may go out of business because they operate at higher costs.
On the other hand, efficiency is also the key to being competitive in the international market. Domestic companies have to compete with companies from other countries. Efficiency allows them to sell at lower prices to attract more overseas demand.
Obtaining the required resources
International trade facilitates the domestic economy’s obtaining of several key inputs. For example, some natural resources or capital goods may not be available domestically, so we have to import them from abroad.
Some developed countries, for example, are poor in natural resources as raw materials and inputs such as oil and metallic minerals. Thus, they depend on imports to fill their factories.
Conversely, developing countries are often poor in high-tech capital goods (machinery and equipment). To support their production, they have to import such goods from developed countries.
More efficient resource allocation
Specialization encourages countries to mobilize their resources to their highest use. Therefore, they focus on products in which they have a comparative advantage.
Specialization is necessary because a country does not have all the resources it needs to produce at the most efficient level. For instance, some countries have abundant natural resources. While others have abundant capital and entrepreneurship. Which factor is plentiful, we call the factor endowments.
Different factor endowments make one country more efficient at producing certain goods and services than others. Thus, when each country specializes based on these factors, they can deliver goods at lower costs.
As a result, specialization allows countries to maximize resources at their highest use. So, they do not squander their scarce resources to produce goods and services at relatively high costs.
Source of foreign exchange reserves
We earn foreign currency as compensation when we sell goods and services abroad. We may use some of it to pay for goods we import and pay foreign obligations such as foreign debts. Foreign exchange reserves accumulate when foreign currency inflows exceed foreign currency-denominated payments.
Foreign exchange reserves are vital for financing imports and foreign debt because they act as shock absorbers when shocks occur in the domestic currency exchange rate. Moreover, central banks use them to intervene in the foreign exchange market to help maintain a stable exchange rate, avoiding an exchange rate crisis.
New skills and technology transfer
International trade allows new ideas, skills, and technologies to spread across countries. They don’t just spread through education or direct investment. But, they also spread through international trade.
For example, when we buy capital goods from abroad, we don’t just purchase physical goods. We also import related skills and technologies, including knowledge of how to use them. As a result, international trade contributes to the transfer of new skills and technologies from one country to another.
As a growth engine
International trade contributes to an increase in long-term output. As noted earlier, technology transfer spreads through trade, primarily through imports of capital goods and openness to export markets. As a result, it drives technological progress and increases total factor productivity (TFP), a key to long-term growth.
In addition, market expansion through exports stimulates aggregate demand, which in turn, stimulates aggregate output. Remember, GDP based on expenditure is calculated by adding household consumption, business investment, government spending, and net exports.
- GDP = Household consumption + Business investment + Government spending + Exports – Imports
Thus, the greater the export, the higher the GDP. Economists use GDP to measure the economy’s output. In other words, the higher the export, the higher the GDP and the greater the output, ceteris paribus.
China is a good example. The country reported exports growing by an average of 20.3% between 2000 and 2003 after growing 12.4% in the 1990s. The rapid increase in exports made China a country with prominent economic development, where annual economic growth reached an average of 9.0% during 1970-2003.
