International Trade

International Trade — Meaning & Importance

• International trade is the exchange of goods and services between residents of different countries. It exists because no country is self-sufficient — Nepal imports petroleum from India, exports readymade garments and carpets to the USA and Germany, imports electronics from China. Trade brings several benefits: (1) specialisation — each country produces what it is best at
• (2) variety — Nepali consumers enjoy Indian mangoes, Korean televisions, Chinese toys
• (3) lower prices — competition reduces prices
• (4) technology transfer — importing machinery brings new technology
• (5) larger market — Nepali pashmina reaches Europe and Japan
• (6) better relations between nations. The theory of comparative advantage by David Ricardo (1817) explains why trade benefits all parties.

Balance of Trade (BOT) vs Balance of Payment (BOP)

Balance of Trade (BOT) is the difference between the value of visible goods exported and imported by a country in a year. It records only physical goods — not services. Balance of Payment (BOP) is a broader, more complete record — it records all international transactions of a country with the rest of the world in a year — visible trade (goods), invisible trade (services like tourism, remittances, banking, insurance), capital flows (FDI, portfolio investment, loans), and changes in official foreign-exchange reserves. Nepal's BOP has four accounts: (i) Current Account (goods + services + income + transfers), (ii) Capital Account, (iii) Financial Account (FDI, loans), (iv) Net Errors & Omissions.

Trade Deficit & Exchange Rate

1. promote export-oriented industries (handicrafts, pashmina, tea, cardamom, handicrafts)
2. diversify export destinations (reduce over-dependence on India)
3. import substitution — produce at home what we import (e.g. cement factories replacing imported cement)
4. reduce luxury imports through tariffs
5. encourage tourism and remittance to cover deficit on services account. The exchange rate is the price of one currency in terms of another — e.g. 1 USD = Rs 133, 1 INR = Rs 1.60 (Nepal pegs NPR to INR at a fixed ratio of 1.6 since 1993). There are two main exchange-rate systems: fixed (pegged) — the central bank buys/sells foreign currency to keep the rate constant; and floating (flexible) — the rate is determined by market demand and supply of foreign exchange

Free Trade vs Protectionism

• Free trade is a policy where the government does not restrict international trade — no tariffs, no quotas, no subsidies. Arguments for free trade: (1) comparative advantage — each country specialises
• (2) lower prices for consumers
• (3) wider variety
• (4) technology transfer
• (5) global cooperation. Protectionism is the opposite — the government uses tools like tariffs (import duty), quotas (quantity limit), subsidies to domestic producers, and embargoes (total ban) to protect domestic industries from foreign competition. Arguments for protectionism: (1) infant-industry argument — new domestic industries cannot compete with established foreign firms (Nepal's garment industry needs protection)
• (2) employment — protect domestic jobs
• (3) self-reliance — strategic goods (food, defence) should be home-produced
• (4) anti-dumping — prevent foreign firms selling below cost
• (5) diversification — encourage new sectors. Nepal follows a mixed approach — WTO member since 23 April 2004, SAFTA member since 2006, but maintains tariffs to protect agriculture and small industries.

Comparative Advantage Theory (David Ricardo)

In 1817, David Ricardo extended Adam Smith's absolute advantage theory with the theory of comparative advantage. Ricardo argued that even if one country is more efficient than another in producing both goods (absolute advantage in both), trade is still mutually beneficial if each specialises in the good in which it has lower opportunity cost. Example: Suppose in Nepal 1 labour-hour produces either 10 kg of rice or 5 metres of cloth (opportunity cost of 1 m cloth = 2 kg rice). In India, 1 labour-hour produces either 20 kg of rice or 20 metres of cloth (opportunity cost of 1 m cloth = 1 kg rice). India has absolute advantage in both goods, but Nepal has comparative advantage in rice (it gives up only 0.5 m cloth per kg of rice vs India's 1 m cloth per kg), while India has comparative advantage in cloth (it gives up only 1 kg rice per m cloth vs Nepal's 2 kg). Both gain if Nepal specialises in rice and India in cloth, then trade. The gains from trade come from different opportunity-cost ratios between countries.