International Trade Theory and Policy
by Steven M. Suranovic

Trade 5-1

The International Economy

International economics is growing in importance as a field of study because of the rapid integration of international economic markets. More and more, businesses, consumers and governments realize that their lives are increasingly affected, not just by what goes on in their own town, state or country, but by what is happening around the world. Consumers can buy goods and services from all over the world in their local shops. Local businesses must compete with these foreign products. However, these same businesses also have new opportunities to expand their markets by selling in a multitude of other countries. The advance of telecommunications is rapidly reducing the cost of providing services internationally and the internet will assuredly change the nature of many products and services as it expands markets even further than today.

Markets have been going global, and everyone knows it.

One simple way to see this is to look at the growth of exports in the world during the past 50+ years. The following figure shows overall annual exports measured in billions of US dollars from 1948 to 2005. Recognizing that one country's exports are another country's imports, one can see the exponential growth in trade during the past 50 years.

However, rapid growth in the value of exports does not necessarily indicate that trade is becoming more important. Instead, one needs to look at the share of traded goods in relation to the size of the world economy. The adjoining figure shows world exports as a percentage of world GDP for the years 1970 to 2005. It shows a steady increase in trade as a share of the size of the world economy. World exports grew from just over 10% of GDP in 1970 to almost 30% by 2005. Thus, trade is not only rising rapidly in absolute terms, it is becoming relatively more important too.

One other indicator of world interconnectedness can be seen in changes in the amount of foreign direct investment (FDI). FDI is foreign ownership of productive activities and thus is another way in which foreign economic influence can affect a country. The adjoining figure shows the stock, or the sum total value, of FDI around the world taken as a percentage of world GDP between 1980 and 2004. It gives an indication of the importance of foreign ownership and influence around the world. As can be seen, the share of FDI has grown dramatically from around 5% of world GDP in 1980 to over 20% of GDP just 25 years later.

The growth of international trade and investment has been stimulated partly by the steady decline of trade barriers since the Great Depression of the 1930s. In the post World War II era the General Agreement on Tariffs and Trade, or GATT, was an agreement that prompted regular negotiations among a growing body of members to reduce tariffs (import taxes) on imported goods on a reciprocal basis. During each of these regular negotiations, (eight of these rounds were completed between 1948 and 1994), countries promised to reduce their tariffs on imports in exchange for concessions, or tariffs reductions, by other GATT members. When the most recent completed round was finished in 1994, the member countries succeeded in extending the agreement to include liberalization promises in a much larger sphere of influence. Now countries would not only lower tariffs on goods trade, but would begin to liberalize agriculture and services market. They would eliminate the many quota systems - like the multi-fiber agreement in clothing - that had sprouted up in previous decades. And they would agree to adhere to certain minimum standards to protect intellectual property rights such as patents, trademarks and copyrights. The WTO was created to manage this system of new agreements, to provide a forum for regular discussion of trade matters and to implement a well-defined process for settling trade disputes that might arise among countries.

As of 2006, 149 countries were members of the WTO "trade liberalization club" and many more countries were still negotiating entry. As the club grows to include more members, and if the latest round of trade liberalization discussion called the Doha round concludes with an agreement, world markets will become increasingly open to trade and investment. [Note: the Doha round of discussions was begun in 2001 and remains uncompleted as of 2006]

Another international push for trade liberalization has come in the form of regional free trade agreements. Over 200 regional trade agreements around the world have been notified, or announced, to the WTO. Many countries have negotiated these with neighboring countries or major trading partners, to promote even faster trade liberalization. In part these have arisen because of the slow, plodding pace of liberalization under the GATT/WTO. In part it has occurred because countries have wished to promote interdependence and connectedness with important economic or strategic trade partners. In any case, the phenomenon serves to open international markets even further than achieved in the WTO.

These changes in economic patterns and the trend towards ever increasing openness are an important aspect of the more exhaustive phenomenon known as globalization. Globalization more formally refers to the economic, social, cultural or environmental changes that tend to interconnect peoples around the world. Since the economic aspects of globalization are certainly one of the most pervasive of these changes, it is increasingly important to understand the implications of a global marketplace on consumers, businesses and governments. That is where the study of international economics begins.


International Trade Theory and Policy - Chapter 5-1: Last Updated on 12/24/06