IFM6th_compressed-49-89

Chapter 2: International Trade and Investment: Measurement and Theories

2.1 Introduction to International Trade and Investment

  • International business relies on markets that facilitate fund flows between countries.

  • Principal International Transactions include:

    • Borrowing from abroad by governments/businesses

    • Lending abroad, investing in foreign shares, and setting up subsidiaries

    • Payments for imports

    • Receipts for exports

  • Balance of Payments (BOP) serves as a record of these transactions.

2.2 Learning Objectives

  • Explain key components of the BOP.

  • Discuss the influence of economic and political factors on trade.

  • Examine characteristics of different countries.

  • Analyze principal economic theories related to international trade.

2.3 Importance of the Balance of Payments

  • Financial managers monitor BOP to assess a country's transaction dynamics and economic health.

  • BOP indicates economic stability and potential shifts in tariffs and exchange rates.

  • Components of BOP:

    • Current Account: Records export/import of goods and services.

    • Capital Account: Tracks intergovernmental transactions, albeit smaller than the current account.

    • Financial Account: Summarizes investments into/out of a country.

2.4 Structure of the Balance of Payments

  • Current Account: Key elements include exports, imports, income from investment, and secondary income.

  • Capital Account: Notable for capital transfers and other long-term transfers.

  • Financial Account: Includes both portfolio and direct investments:

    • Portfolio Investment: Less than 10% ownership, no management interest.

    • Direct Investment: More than 10% ownership, managerial interest in operations.

2.5 Recording Currency Transactions

  • Cross-border transactions require exchanges of home and foreign currencies.

  • Transactions balance because every trade leads to currency demand and supply.

2.6 Examples of Balance of Payments Transactions

  • Direct transaction example illustrating import/export implications in current and financial accounts.

  • Focus on accounting principles and challenges of estimations relevant to BOP.

2.7 Reasons for Balance of Payments Equilibrium

  • BOP balances due to equal demand and supply in currency exchanges during international transactions.

  • Old vs. new formats of recording BOP transactions emphasize recent IMF guidelines.

2.8 The Role of Multinationals

  • Multinational Corporations (MNCs) contribute actively to local economies, affecting the BOP through investments and operational activities.

  • Operations can include subsidiaries and sourcing from foreign markets.

2.9 Economic Perspectives

  • Mercantilist views equate a positive current account with wealth, contrary to views arguing that negative balances are not always detrimental.

  • Current Account Balances and GDP Relationship:

    • Solvent economies like Germany have surpluses; deficit countries do not necessarily correlate with weaker economies.

2.10 Factors Impacting International Trade Flows

  • Key Influencing Factors:

    1. Inflation: Higher domestic inflation leads to a decrease in current account.

    2. National Income: An increase in national income can result in increased imports.

    3. Government Restrictions: Tariffs and quotas significantly impact trade.

    4. Exchange Rates: Stronger currencies impact import/export dynamics, potentially leading to deficits.

2.11 The Marshall-Lerner Condition

  • States conditions under which currency devaluation improves balance of payments; a form of elasticity must be met.

  • Describes short-term underperformance of trade balances post-devaluation (J-curve effect).

2.12 International Capital Flows

  • Financial account reflects direct foreign investment (DFI) and portfolio investments influenced by economic growth potential, tax attractiveness, etc.

2.13 Economic Theories of International Trade

  1. Mercantilism: Advocates for export supremacy and import restrictions for national wealth.

  2. Absolute and Comparative Advantage: Countries benefit by specializing in the production where they have efficiency.

  3. Heckscher-Ohlin Theorem: Resource abundance drives trading patterns.

  4. Imperfect Markets: Limitations on the mobility of factors necessitate investment in foreign markets to harness local resources.

  5. Product Cycle Theory: Firms evolve from local to global markets based on product demand.

2.14 Agency Support for Trade and Investments

  • Organizations such as the IMF, World Bank, WTO, and regional development banks facilitate international trading and financial transactions.

  • IMF: Monitors BOP and influences economic policies in member countries via conditional funding.

  • World Bank: Focuses on economic development through lending for projects that foster growth.

  • WTO: Provides a forum for trade negotiations and dispute resolution.

2.15 Conclusion and Summary

  • Current Account Components: Focus on goods/services, income flows, and current transfers.

  • Economic factors, government policies, and currency conditions directly affect BOP.

  • Balance of Payments serves multiple roles, influencing international trade dynamics and MNC activities.