Management of Foreign

Trade
Chapter 01
Introduction
Prepared by
Kazi Romana Akter
Lecturer, Mgt., CU
Contents:
• Foreign Trade: Definition
• Nature and Types of Foreign Trade
• Features of Foreign Trade
• Need / Importance / Advantages of Foreign Trade
• Theories of International Trade
Absolute Advantage Theory,
Comparative Advantage Theory,
Opportunity Cost Theory
Heckscher-Ohlin Theory
• Legal requirements for foreign trade
• Free Trade and Protectionism
Foreign Trade: Definition

• Foreign trade is the exchange of capital, goods, and services across international borders or territories.
• In most countries, it represents a significant share of gross domestic product (GDP). Industrialization,
advanced transportation, globalization, multinational corporations, and outsourcing are all having a major
impact on the international trade system. Increasing international trade is crucial to the continuance of
globalization. International trade is a major source of economic revenue for any nation that is considered a
world power. Without international trade, nations would be limited to the goods and services produced within
their border.
• Foreign trade is the exchange of goods across national boundaries. Prof. J.L. Hanson said, “An exchange of
various specialized commodities and services rendered among the corresponding countries is known as
foreign trade.”
Nature of Foreign Trade

• Foreign trade is, in principle, not different from domestic trade as the motivation and the behavior of parties
involved in a trade does not change fundamentally depending on whether a trade is across a border or not.
• The main difference is that international trade is typically more costly than domestic trade. The reason is that
a border typically imposes additional costs such as tariffs, time costs due to border delays, and costs
associated with country differences such as language, the legal system, or a different culture. Foreign trade is
all about imports and exports. The backbone of any foreign trade between nations is those products and
services which are being traded to some other location outside a particular country’s borders.
• Some nations are adept at producing certain products at a cost-effective price. Perhaps it is because they have
the labor supply or abundant natural resources which make up the raw materials needed. No matter what the
reason, the ability of some nations to produce what other nations want is what makes foreign trade work.
Types of Foreign Trade

• Export: Exporting is selling domestic-made goods in another country. For example, Hameem Garments
exports Readymade Garments (RMG) products to Western Countries.
• Import: Importing is the purchasing of goods or services made in another country. For example, importing
edible oil from Chinese producers to sell in Africa.
• Re-export: When goods are imported from a foreign country and are re-exported to buyers in some other
foreign countries, it is called re-export. For example, Firm/ Readymade Garments located at EPZs imports
raw materials (cotton) from Korea and produces Readymade Garments products by Thai cotton and then
those products to Canada.
Features of Foreign Trade
• Import dependency (our country foreign trade depend on import because of high demand and low supply),
• Import capital goods and industrial goods,
• Export of readymade garments (RMG), RMG and Knitwear 74% export,
• Export of agricultural raw materials and products,
• Unfavorable balance of payment ( More import but less export),
• Operate most business by sea/ocean,
• More import from Asia (China, Singapore, India ) and export in Western countries (USA, England),
• Government initiation and control (By TCB and EPB govt control foreign trade and operate helpful
initiative),
• Export of jute and jute goods,
• Export of manpower,
Features of Foreign Trade

• Private initiative,
• Diversity of import goods (necessary goods and unnecessary luxurious goods ),
• Effect of free trade economy (for open market economy unnecessary luxurious goods are imported in our
country, and our country’s money went to another country),
• Business with all countries.
Need / Importance / Advantages of Foreign Trade

• Division of Labor and Specialization

Foreign trade leads to the division of labor and specialization at the world level. Some countries have abundant
natural resources. They should export raw materials and import finished goods from countries which are
advanced in skilled manpower. This gives benefits to all the countries and thereby leading to the division of
labor and specialization.
• Optimum Allocation and Utilization of Resources
Due to specialization, unproductive lines can be eliminated, and wastage of resources avoided. In other words,
resources are canalized for the production of only those goods, which would give the highest returns. Thus there
is rational allocation and utilization of resources at the international level due to foreign trade.
• Equality of Prices
Prices can be stabilized by foreign trade. It helps to keep the demand and supply position stable, which in turn
stabilizes the prices, making allowances for transport and other marketing expenses.
• Availability of Multiple Choices
Foreign trade helps in providing a better choice to the consumers. It helps in making available new varieties to
consumers all over the world.

• Ensures Quality and Standard Goods

Foreign trade is highly competitive. To maintain and increase the demand for goods, the exporting countries have
to keep up the quality of goods. Thus quality and standardized goods are produced.

Moreover, International trade is the vehicle for the transmission of new ideas, new technology, and new
managerial and other skills. Trade also stimulates and facilitates the international flow of capital from developed
to developing nations. In the case of foreign direct investments, where the foreign firm retains managerial control
over its investment, the foreign capital is likely to be accompanied by foreign skilled personnel to operate it. In
several large developing nations, such as Brazil and India, the importation of new manufactured products
stimulated domestic demand until efficient domestic production of these goods became feasible. Finally,
international trade is an excellent antimonopoly weapon because it stimulates greater efficiency by domestic
producers to meet foreign competition.
Theories of International Trade

Absolute Advantage Theory:

According to Adam Smith, trade between two nations is based on absolute advantage.
When one nation is more efficient than another in the production of one commodity but is less efficient than the
other nation in producing a second commodity, then both nations can gain by each specializing in the production of
commodity of its absolute advantage and exchanging part of its output with other nation for the commodities of its
absolute disadvantage.

Example:

Bangladesh India

Wheat (bushels/man hour) 6 1

Cloth (Yards/man hour) 4 5

Comparative Advantage Theory

In 1817, Ricardo published his “Principles of Political Economy and Taxation”, in which he presented the law of
comparative advantage. According to the law of comparative advantage even if one nation is less efficient than
the other nation in the production of both commodities, there is still a basis of mutually beneficial trade.

The first nation should specialize in the production of and export the commodity in which its absolute
disadvantage is smaller and import the commodity in which its absolute disadvantage is greater.

Example:
Bangladesh India
Wheat (bushels/man hour) 6 1
Cloth (Yards/man hour) 4 2

Since India is half as productive in but six times less productive in wheat with respect to Bangladesh, India has a
comparative advantage in cloth. But Bangladesh has an absolute advantage in both wheat and cloth respect to the
India, since its absolute advantage is greater in wheat than in cloth, Bangladesh has a comparative advantage in
wheat.
The Gains from Trade:
Bangladesh gains to the extent that it can exchange 6W for more than 4C from the India. The India gains to the
extent that it can give up less than 12C for 6W from the Bangladesh. The range for mutually advantageous trade is:

4C<6W<12C

Exception of the Law of Comparative Advantage:

There is one exception to the law of comparative advantage. This occurs when the absolute disadvantage that one
nation has with respect to another is the same in both commodities. For example, if one hour produced 3W instead
of 1W in the India , the India would be exactly half as productive as the Bangladesh in both wheat and cloth. The
India (and Bangladesh) would then have a comparative advantage in neither commodity, and no mutually beneficial
trade could take place.

Bangladesh India

Wheat (bushels/man 6 3
hour)
Cloth (Yards/man hour) 4 2
Comparative Advantage with Money
According to the law of comparative advantage theory, there will be mutually benefited international
trade when wage is comparatively less in the nation where there are absolute disadvantage in both the
goods.
The wages in the India will be sufficiently lower than wages in the Bangladesh so as to make the price
of cloth (the commodity in which the India has a comparative advantage) lower in the India, and the
price of wheat lower in the Bangladesh when both commodities are expressed in terms of the currency
of either nation.
Comparative Advantage and Opportunity Costs
Ricardo based his law of comparative advantage on a number of simplifying assumptions:
(1) only two nations and two commodities,
(2) free trade,
(3) perfect mobility of labor within each nation but immobility between the two nations,
(4) constant costs of production,
(5) no transportation costs,
(6) no technical change, and
(7) the labor theory of value. Although assumptions one through six can easily be relaxed, assumption
seven (i.e., that the labor theory of value holds) is not valid and should not be used for explaining
comparative advantage.
The Opportunity Cost Theory
Given by Haberler in 1936

According to the opportunity cost theory, the cost of a commodity is the amount of a second commodity that
must be given up to release just enough resources to produce one additional unit of the first commodity. No
assumption is made here that labor is the only factor of production or that labor is homogeneous.
For example, if in the absence of trade the Bangladesh must give up two-thirds of a unit of cloth to release just
enough resources to produce one additional unit of wheat domestically, then the opportunity cost of wheat is
two-thirds of a unit of cloth i.e., 1W = 2/ 3C in the Bangladesh.
If 1W = 2C in the India, then the opportunity cost of wheat (in terms of the amount of cloth that must be given
up) is lower in the Bangladesh than in the India, and the Bangladesh would have a comparative (cost)
advantage over the India in wheat. In a two-nation, two-commodity world, the India would then have a
comparative advantage in cloth.
Opportunity costs can be illustrated with the production possibility frontier, or transformation curve. The
production possibility frontier is a curve that shows the alternative combinations of the two commodities that a
nation can produce by fully utilizing all of its resources with the best technology available to it

Production Possibility Schedules

Bangladesh India
Wheat Cloth Wheat Cloth
180 0 60 0
150 20 50 20
120 40 40 40
90 60 30 60
60 80 20 80
30 100 10 100
0 120 0 120

In the absence of trade, the Bangladesh might choose to produce and consume combination (90W and 60C) on
its production possibility frontier, and the India might choose combination (40W and 40C)
The Production Possibility Frontiers of the Bangladesh and the India.
The production frontiers are obtained by plotting the values in the Table. The frontiers are downward, or
negatively sloped, indicating that as each nation produces more wheat, it must give up some cloth. Straight-
line production possibility frontiers reflect constant opportunity costs.

Bangladesh
India
120
120

Cloth
Cloth 60
40

90 180 40 60
Wheat Wheat

FIGURE: The Production Possibility Frontiers

The Basis for and the Gains from Trade under Constant Costs
In the absence of trade, a nation can only consume the commodities that it produces. As a result, the nation’s
production possibility frontier also represents its consumption frontier. Which combination of commodities the
nation actually chooses to produce and consume depends on the people’s tastes, or demand considerations.
Due to presence of international trade, both nation will be specialized in product where it has lower
opportunity cost in comparison to the other country and then exchange with other product of another country.
Both nation will be mutually benefitted and world production will increase.
Heckscher-Ohlin Theory

Introduction
• Eli Heckscher and Bertin Ohlin explained the basis of trade between two countries on the basis of differences in
relative factor endowments.
• The H.O theory states that the main determinant of the pattern of Production, Specialisation and trade among
regions is the relative availability of factor endowments and factor prices.
• “some countries have much capital, others have much labour. The theory now says that countries that are rich in
capital will export capital-intensive goods and countries that have much labour will export labour-intensive
goods.”
Evolution of H.O theory:
Bertin Ohlin in his famous book Inter-regional and International Trade (1933) criticized the classical
theory of international trade and formulated the General Equilibrium or factor endowment theory. It is
also known as Heckscher – Ohlin theory. In fact Eli Heckscher, Ohlin’s teacher, who first propounded
the idea in 1919 that trade results from differences in factor endowments in different countries, and
Ohlin carried it forward to build the modern theory of international trade.
Assumptions:
1. It is a two-by-two-by-two model, there are two countries (A and B), two commodities (X and Y) and
two factors of production ( capital and Labour).
2. There is perfect competition in commodity as well as factor markets.
3. There is full employment of resources
4. The production functions of the two commodities have different factor intensities, i.e labour intensive
and capital intensive.
5. Factor intensities are non- reversible
6. There is perfect mobility of factors within each region but internationally they are immobile.
7. There are no transport costs.
8. There is free and unrestricted trade between the two countries
9. There is no change in technological knowledge.
10. There are constant return to scale in the production of each commodity in each region.
11. Taste and preferences of consumers and their demand patterns are identical in both countries.
12. There is incomplete Specialisation. Neither country specializes in the production of one commodity.

H.O theory:
 International trade occurs because there are differences in relative commodity prices caused by differences in
relative factor prices (thus a comparative advantage) as a result of differences in the factor endowments among
the countries.
 The H.O theorem is explained in terms of two conceptions (a) factor abundance (or scarcity) in terms of the price
criterion; and (b) factor abundance (or scarcity) in terms of the physical criterion.
Factor Abundance in terms of Factor Prices :
Heckscher – Ohlin explain richness in factor endowment in terms of factor prices. According to their definition,
country A is abundant in capital if (P𝐾/PL) A < (PK/PL) B, where PK and PL refers to prices of capital and labour,
and the subscripts A and B denote the two countries.
• In other words , if capital is relatively cheap in country A, the country is abundant in capital , and if labour is
relatively cheap in country B, the country is abundant in labour.
• Thus country A will produce and export the capital – intensive good and import the labour – intensive good and
country B will produce and export the labour- intensive good and import the capital – intensive good.
X be the labour - intensive commodity Y be the capital -
intensive commodity • Red line country A produce both
commodity X and Y • -------- country B produce both
commodity X and Y

Let X be the labour - intensive commodity taken on the

horizontal axis and Y be the capital - intensive commodity
taken on the vertical axis, XX is the isoquant of
commodity X and YY that of commodity Y. They are the
same for both the countries A and B. The relative factor
prices in country A for both the commodities are given by
the factor price line AA1. Assuming that each isoquant
represent one unit of the respective commodity, then 1
units of Y will be produced with OC amount of capital
and OD amount of labour at point E where the isocost line
AA1 is tangent to the isoquant YY. By the same
reasoning, we find that the cost of producing one unit of
commodity X in country A is OM amount of capital and
ON amount of labour.
Since capital is abundant and cheap in country A, it will specialize in the production of the capital
intensive commodity Y. In order to produce 1 unit of Y it uses more amount of capital OC and OD
amount of labour at point E on the isoquant YY. While at point L on the isoquant XX, it uses less
amount of capital OM with more of labour ON in order to produce 1 unit of X. Hence country A will
produce and export the relatively capital abundant and cheap commodity to the other country B. In order
to find out the cost of producing one unit of each commodity in country B where labour is relatively
cheap and abundant, draw a flatter factor price BB3 tangent to the isoquant YY at point G. A similar
factor price line B1B2 is drawn parallel to BB3 which is tangent to the isoquant XX at point S.

Now it requires OK amount of capital and OH amount of labour to produce one unit of commodity Y in
country B, and OT amount of capital and OR amount of labour to produce one unit of commodity X in
this country. Since labour is cheap and abundant in country B, it will specialize in the production of
labour -intensive commodity X. So it will produce commodity X at point S on the isoquant XX, which
requires more labour OR with less amount of capital OT than commodity Y which requires less amount
of labour OH with more amount of capital OK at point G on the isoquant YY. Hence country B will
export commodity X (labour) to country A in exchange for commodity Y.
• This establishes the H.O theorem that the capital abundant country will export the relatively cheap
capital - intensive commodity, and the labour abundant country will export the relatively cheap labour –
intensive commodity.
Criticisms:
• Two-by-two-by-two model
• Static theory
• Factor not Homogeneous
• Production Techniques not Homogeneous
• Taste and Demand pattern no identical
• No Constant Return
• Transport costs influence Trade
• Unrealistic Assumption of Full employment and perfect competition
• Leontief paradox has falsified the theory
• Partial equilibrium analysis
• Factor prices do not determine commodity prices
Despite these criticism, the Ohlin theory of international trade is definitely an improvement over the classical
theory as it attempts to explain the basis of international trade in the general equilibrium setting.
Legal requirements for foreign trade:
• Tariffs and taxes: Many countries impose tariffs on imported goods, which can be based on a percentage of the
cost or a set amount per item. Exports may also be subject to a Value Added Tax (VAT).
• Documentation: Almost all countries require documentation for imported products.
• Safety, quality, and conformity: Countries have regulations to ensure that imported products meet safety,
quality, and conformity standards.
• Free Trade Agreements (FTAs): FTAs allow commerce across borders without tariffs.
• Trade agreements: Trade agreements set tariffs and duties between countries.
• Intellectual Property Rights Agreements: These agreements cover manufactured products and services.
• Foreign Exchange Regulation Act: This act regulates payments, dealings in foreign exchange and securities,
and the import and export of currency and bullion.
• Ministry of Commerce guidelines: Exporters in Bangladesh must comply with the guidelines of the Ministry of
Commerce, which are published in the Import Policy Order and Export Policy.
Free Trade and Protectionism
Free trade and protectionism represent two opposing approaches to international trade. Free trade emphasizes
the removal of trade barriers, promoting economic efficiency and market access. Protectionism aims to protect
domestic industries but can lead to higher prices and reduced consumer choice. The balance between free trade
and protectionism remains a subject of ongoing policy discussions, with countries adopting varying degrees of
openness and protectionism based on their economic priorities and circumstances.

Free Trade
Free trade promotes the unrestricted flow of goods and services across borders. Its proponents argue that
removing barriers to trade leads to economic growth, efficiency, and consumer benefits. Free trade agreements,
such as the North American Free Trade Agreement (NAFTA) and the Comprehensive and Progressive
Agreement for Trans-Pacific Partnership (CPTPP), aim to reduce trade barriers and promote market access.
Free trade agreements have contributed to the reduction of tariff barriers, facilitating trade between
participating countries.
Protectionism
Protectionism, on the other hand, seeks to shield domestic industries from foreign competition by imposing
trade barriers. This can take the form of tariffs, which are taxes on imported goods, or non-tariff measures such
as quotas, subsidies, and local content requirements. Protectionist policies are often implemented to safeguard
domestic employment, industries, and national security interests.
Arguments for Free Trade
There are several key arguments in favor of free trade:
•Free trade increases the size of the economy as a whole. It allows goods and services to be produced more
efficiently. That’s because it encourages goods or services to be produced where natural resources,
infrastructure, or skills and expertise are best suited to them. It increases productivity, which can lead to higher
wages in the long term. There is widespread agreement that rising global trade in recent decades has increased
economic growth.

•Free trade is good for consumers. It reduces prices by eliminating tariffs and increasing competition. Greater
competition is also likely to improve quality and choice. Some things, such as tropical fruit, would not be
available in the UK without trade.

•Reducing non-tariff barriers can remove red tape, thus reducing the cost of trading. If companies that trade in
several countries have to work with only one set of regulations, their costs of ‘compliance’ come down. In
principle, this will make goods and services cheaper.

•In contrast, protectionism can result in destructive trade wars that increase costs and uncertainty as each side
attempts to protect its own economy. Protectionist rules can tend to favour big business and vested interests, as
they have the resources to lobby most effectively.
Arguments for Protectionism
While free trade increases the size of the economy as a whole, it isn’t always good for everyone:
•As more countries experience industrial development, traditional domestic industries can decline. In the UK,
for example, the shipbuilding industry has declined in the face of international competition since the 1950s
and currently steel production faces increasing competition. Protectionism can help preserve jobs in these
sectors, or at least slow the process of change.

•Protectionism can also help build up new industries. In sectors with high start-up costs, new firms might find
it difficult to compete if there is not support from government in the form of tariffs or subsidies. Once they
have become competitive, such barriers can be removed.

•Protectionism can be used to safeguard ‘strategic’ industries such as energy, water, steel, armaments and food.
For example, ‘food security’ may be seen as important so that we can feed ourselves if something terrible
happens to disrupt the system of world trade.

•Some people worry that free trade deals can lead to a lowering of standards. Such deals might require us to
let in goods and services even though they don’t meet our standards, which might then be cheaper than those
made by domestic industries. For example, some people have been worried recently that a free trade deal with
the US might let in imports of chlorine-washed chicken. There might also be pressure to reduce our standards
for workers’ rights or environmental protection so that our companies can compete with companies in
countries that have lower standards.