Level 1 CFA® Exam:
International Trade and Capital Flows
Gross National Product (GNP) is a category similar to that of gross domestic product (GDP). While GDP measures the value of goods and services produced in a given country, GNP is the measure of the value of goods and services produced by this country’s citizens. Thus, GNP doesn’t account for the income of the foreigners living in the country. However, it does take into account the income of its citizens who live abroad.
The benefits of international trade include:
- exchange resulting from trade and advantages resulting from specialization,
- economies of scale, which generally means that the market is getting larger,
- greater variety of products and services,
- stronger competition and more efficient allocation of resources.
As far as the costs of international trade are concerned, they are mainly borne by domestic industries that have to compete with producers from abroad.
Trade is associated not only with benefits and costs. It has also its restrictions, among which we distinguish:
- tariffs, that is taxes on imported goods,
- quotas, which are quantitative limits on imports of goods,
- voluntary export restraints (VER), which involve voluntary decisions of an exporting country concerning the quantity of a good that the exporting country is allowed to export to another country,
- export subsidy, which is money paid by a country to a company when the company exports goods that are subsidized,
- domestic content provisions, which are requirements concerning product components and what part of it should come from the domestic country.
Generally, trade restrictions lead to higher prices and a decline in the volume of imports which results in higher demand for domestic goods. As a consequence, producer surplus increases and consumer surplus decreases.
(...)
Trade leads to movements of capital. These movements are sometimes restricted by the government.
Restrictions on the movement of capital include:
- regulations prohibiting foreigners from investing in a country,
- regulations prohibiting citizens from investing abroad,
- regulations prohibiting foreign investments in selected sectors of an economy and strategic industries like defense or telecommunication,
- restrictions on the repatriation of profits generated by foreign entities.
- taxes on foreign investment.
Restriction on capital flows:
- gives the country control over its external balance,
- when imposed on capital outflows, the restrictions will most likely result in lower interest rates in the country
- and lower costs of debt for the government.
The basic motivation for creating trading blocs is to eliminate barriers to trade and barriers to the movement of factors of production among the members of the block.
Trading blocks may take many forms:
- In a free trade area (FTA), all trade barriers between partners are eliminated but each country has its own policy against non-members.
- In the case of a custom union, all trade barriers between partners are eliminated and all countries have the same policy against non-members.
- A common market incorporates all aspects of a customs union and extends it by allowing free movement of labor and capital among members.
- An economic union incorporates all aspects of a common market and additionally requires common economic institutions and coordination of economic policies among members.
- In a monetary union, all members have a common currency.
Usually, trading blocks are created by countries from the same region. That’s because it’s easier and faster to negotiate regional trading agreements than negotiate multilateral trade deals covering a vast number of countries.
(...)
A balance of payment is made up of the following elements:
- a current account that covers trade in goods and services, foreign income from dividends, interest on debt, and cash transfers from people working abroad, foreign direct aid & gifts.
- a capital account that covers capital flows such as debt relief, transfers of fixed assets, and funds for the purchase/sale of fixed assets, as well as the purchase of non-financial assets (like rights, patents, trademarks, etc.),
- a financial account that includes flows arising from the purchase and sale of financial assets abroad and in a domestic country by foreigners.
All the decisions made by consumers, businesses, and governments affect the balance of payments:
- low private savings and high investment translate into a current account deficit that must be financed by net imports,
- all else equal, a government deficit produces a current account deficit and a government surplus leads to a current account surplus,
- a sustained current account deficit contributes to a rise in the risk premium for financial assets of the deficit country,
- low private and government savings relative to domestic investments requires foreign capital investment.
The World Bank helps to create the basic economic infrastructure. This economic infrastructure is the basis for domestic financial markets and the financial industry in developing countries.
The International Monetary Fund (IMF) ensures the stability of the international monetary system, the system of foreign exchange, and the payment system. The IMF monitors the market risk of a given country and global systematic risk.
The World Trade Organization (WTO) supports free trade by providing an institutional and regulatory framework, which is particularly important in the context of the activities of multinational corporations.
- Tariffs are taxes on imported goods.
- Voluntary export restraints (VER) involve voluntary decisions of an exporting country concerning the quantity of a good that the exporting country is allowed to export to another country.
- Export subsidy is money paid by a country to a company when the company exports goods that are subsidized.
- Domestic content provisions are requirements concerning product components and what part of it should come from the domestic country.
- In a free trade area (FTA), all trade barriers between partners are eliminated but each country has its own policy against non-members.
- In the case of a custom union, all trade barriers between partners are eliminated and all countries have the same policy against non-members.
- A common market incorporates all aspects of a customs union and extends it by allowing free movement of labor and capital among members.
- An economic union incorporates all aspects of a common market and additionally requires common economic institutions and coordination of economic policies among members.
- In a monetary union, all members have a common currency.
- The World Bank helps to create the basic economic infrastructure.
- The International Monetary Fund (IMF) ensures the stability of the international monetary system, the system of foreign exchange, and the payment system.
- The World Trade Organization (WTO) supports free trade by providing an institutional and regulatory framework.