Why countries trade
- Imports
- Goods and services bought from other countries — money flows out.
- Exports
- Goods and services sold to other countries — money flows in.
- Free trade
- Trade between countries without tariffs, quotas or other barriers.
- Tariff
- A tax on imports, which raises their price in the home market.
International trade is specialisation and exchange (2.1) applied between countries rather than between people. A country concentrates on what it produces best and trades for the rest, and the reasons follow directly from that.
Countries import because:
• Some goods cannot be produced at home at all — the UK cannot grow bananas or coffee commercially, and has limited reserves of many minerals • Other countries produce some goods more cheaply, because of lower wages, better climate or larger scale • Consumers want variety and choice that domestic producers do not offer • Firms need raw materials and components that are not available at home
Countries export because:
• They can produce some goods better or more cheaply than others can, so there is demand abroad • Selling abroad gives access to a far larger market than the domestic one, allowing economies of scale (2.6) • Exports earn foreign currency, which is needed to pay for imports • Exports create jobs and income at home
The benefits, and the costs
Free trade agreements
A free trade agreement is an arrangement between countries to reduce or remove barriers to trade between them — chiefly tariffs, but also quotas limiting quantities and differences in regulation that make selling abroad difficult.
The European Union is the example the specification names. It goes further than a simple free trade agreement: it is a single market in which goods, services, capital and people can move freely between member states, with common rules and standards so a product legal in one country is accepted in the others. Members also apply a common external tariff to goods from outside. The UK left the EU and now trades with it under a separate agreement.
The arguments for such agreements:
• Cheaper imports for consumers, because no tariff is added to the price • Larger markets for producers, so firms can specialise and gain economies of scale • Simpler trade, because one set of rules replaces many • Closer political ties, which reduce the likelihood of conflict
The arguments against:
• Domestic industries lose the protection of tariffs and may not survive foreign competition, causing structural unemployment • Some control over regulation passes to the agreement rather than staying with the national government • Trade may be diverted from a cheaper producer outside the agreement to a dearer one inside it • Membership usually involves a financial contribution
Worked example
A country is considering joining a free trade agreement with its neighbours. Evaluate the decision.
- Take the consumer benefits first: removing tariffs lowers the price of imports and widens choice.
- Then producers: access to a much larger market allows specialisation and economies of scale, lowering average costs.
- Now the costs, and be specific about who bears them.
- Domestic firms that survived only because tariffs made imports expensive will now face competition they may lose.
- That means job losses concentrated in particular industries and regions — structural unemployment.
- Reach a judgement and say what it depends on.
Answer: Joining benefits consumers through lower prices and more choice, and benefits efficient producers through access to a much larger market and the economies of scale that come with it. The cost falls on industries that were only viable behind tariffs: they face competition they may not survive, and the resulting job losses are concentrated in particular regions, creating structural unemployment. The decision depends on how large and competitive the country's export industries are, and whether the government is prepared to fund retraining for the workers displaced — the gains are spread thinly across all consumers while the losses fall heavily on a few.
Common mistake
Imports and exports are easily reversed under pressure. Imports come in and money goes out; exports go out and money comes in. Getting them the wrong way round makes every subsequent balance of payments answer wrong.
Before you practise
- Imports are bought from abroad; exports are sold abroad.
- Countries import goods they cannot produce, or that others produce more cheaply, and for choice and raw materials.
- Countries export to reach larger markets, gain economies of scale, earn foreign currency and create jobs.
- Consumers gain lower prices, more choice and better quality.
- Producers gain larger markets and cheaper inputs, but face foreign competition.
- Trade can cause structural unemployment where domestic industries decline.
- A free trade agreement removes tariffs and other barriers between members.
- The EU is a single market with free movement of goods, services, capital and people, and common rules.
- Agreements bring cheaper imports and larger markets, but reduce protection for domestic industry and some national control.