7.2 – Globalization and International Trade

Author: Dr. Jean-Paul Rodrigue

International trade is an exchange of goods or services across national jurisdictions. Inbound trade is defined as imports, and outbound trade is defined as exports. International trade is subject to the regulatory oversight and taxation of the involved nations, namely through customs.

1. The Flows of Globalization

In a global economy, no nation is self-sufficient, which is associated with specific flows of goods, people, and information. Each nation is involved at different levels in trade to sell what it produces, to acquire what it lacks, and to produce more efficiently in some economic sectors than its trade partners. International trade, or long-distance trade since there were no nations in the modern sense, has taken place for centuries. It is an important part of human economic and cultural history as ancient trade routes such as the Silk Road can testify and has occurred at an ever-increasing scale over the last 600 years. Trade now plays an even more active part in the economic life of nations and regions, but it should be taking place only if there is a benefit for the partners involved. International trade is an expansion of the market (or exchange) principle at a scale beyond the region or the nation.

The rationale for trade can be a convenience but also a necessity. It is for convenience, as supported by conventional economic theory, when trade promotes economic efficiency by providing a wider variety of goods, often at lower costs. This is because of specialization, economies of scale, and the related comparative advantages. Trade is a necessity when it enables a nation to acquire goods that would otherwise not be available in a national economy such as energy, raw minerals, or even some food. However, the benefits of trade can be subject to contention with several theoretical foundations of international trade have been articulated to explain its rationale:

  • Mercantilism. A trading system where a nation tried to impose a positive trade balance (more exports than imports, particularly value-wise) on other nations to favor the accumulation of wealth. This system was prevalent during the colonial era and often undertaken by charter companies receiving a monopoly on trade. Mercantilism represents the antithesis of free trade since trade relations are controlled and aligned to benefit one partner at the expense of others. Still, mercantilism established the foundations of a global trading system, albeit an unequal one.
  • Neomercantilism. A more recent trade system, which like mercantilism, leans on establishing a positive trade balance to meet economic development goals. Export-oriented strategies can be considered a form of neomercantilism, particularly if a government puts forward an incentive and subsidy system (e.g. free trade zones), which confers additional advantages to the factors of production. Neomercantilism can also be a response by some governments to the competitive and disruptive consequences of free trade, particularly if the trade partners are engaged in neo-mercantilist strategies. The outcomes are tariff and non-tariff measures regulating trade and protecting national commercial sectors that are perceived to be subject to unfair competition. Therefore, neo-mercantilist strategies can be controversial and subject to contention.
  • Absolute advantages. Based on a nation (or a firm) able to produce more effectively in an economic sector while using fewer resources (e.g. capital, labor) than any other potential competitors. It, therefore, has an absolute advantage. Global efficiency can thus be improved with trade as a nation can focus on its absolute advantages, trade its surplus, and import what it lacks. The drawback of this perspective is that, in theory, nations having no absolute advantages should not be involved in trading since they may have little to gain from it. Absolute advantages tend to be an enduring characteristic, particularly for resources such as energy, where large producers keep an advantage as long as a resource is available or has a market.
  • Comparative advantages. Even if a nation (or a firm) has absolute advantages over a wide array of economic sectors, it can focus on the sectors it has the highest comparative advantages (the difference of its production costs and those of its competitors) and import goods in sectors it has less comparative advantages. The comparative productivity increases the total production level since even if a nation (or a firm) has no absolute advantages, it can focus on sectors where the total productivity gains are the most significant. Comparative advantage can also be the outcome of economies of scale applied to a product or sector where the resulting lower costs provide competitiveness. Comparative advantages tend to be a temporary characteristic, that can change with the evolution of labor costs and technology.
  • Factor endowments. Expands the perspective of the comparative advantages by underlining that trade is related to the factor endowments of a nation. The most basic endowments are capital, land, and labor. A nation will export goods to which it has notable factor endowments and import goods in which it has scarce factor endowments. As such, nations that have low-cost labor available will focus on labor-intensive activities, while nations having high capital endowments will focus on capital intensive activities. Factor endowments can be improved through capital and human resources investments.

The globalization of production is concomitant to the globalization of trade as one cannot function without the other. This process has been facilitated by significant technical changes in the transport sector. The scale, volume, and efficiency of international trade have all continued to increase since the 1970s. As such, global space/time convergence was an ongoing process that implied a more extensive market coverage that could be accessed with a lower amount of time. It has become increasingly possible to trade between parts of the world that previously had limited access to international transportation systems. Further, the division and the fragmentation of production that went along with these processes also expanded trade. Trade thus contributes to lower manufacturing costs.

Without international trade, few nations could maintain an adequate standard of living, particularly those of smaller size. With only domestic resources being available, each country could only produce a limited number of products, and shortages would be prevalent. Global trade allows for an enormous variety of resources – from Persian Gulf oil, Brazilian coffee to Chinese labor – to be made more widely accessible. It also facilitates the distribution of a wide range of manufactured goods that are produced in different parts of the world to global markets. Wealth becomes increasingly derived through the regional specialization of economic activities. This way, production costs are lowered, productivity rises, and surpluses are generated, which can be transferred or traded for commodities that would be too expensive to produce domestically or would simply not be available. As a result, international trade decreases the overall costs of production. Consumers can buy more goods from the wages they earn, and standards of living should, in theory, increase.

International trade demonstrates the extent of globalization with increased spatial interdependencies between elements of the global economy and their level of integration. These interdependencies imply numerous relationships where flows of capital, goods, raw materials, people, and services are established between regions of the world. International trade is also subject to much contention since it can, at times, be a disruptive economic and social force as it changes the conditions in which wealth is distributed within a national economy, particularly due to changes in prices, wages and employment sectors. One challenge concerns the substitution of labor and capital. While in simple economy labor and capital (infrastructures) can be reconverted to other uses, in complex economies, labor and capital cannot be easily reallocated. Therefore, trade can, at the same time, lead to more goods being available at a lower price, but with enduring unemployment and decaying infrastructures (unused factories and connectors). In turn, this can incite economies to adopt protectionist policies since this transition is judged to be too disruptive.

2. The Setting of the Contemporary Global Trade System

International trade, both in terms of value and tonnage, has been a growing trend in the global economy. It is important to underline when looking at the structure of global trade that it is not nations that are trading, but mainly corporations with the end products consumed in majority by individuals. A nation is simply a regulatory unit where data is collected since freight crossing boundaries are subject to customs oversight and tabulated as trade flows. Inter and Intra corporate trade is taking place across national jurisdictions is accounted for as international trade. The emergence of the current structure of global trade can mainly be articulated within three major phases:

  • First phase (immobile factors of production). Concerns a conventional perspective on international trade that prevailed until the 1970s, where factors of production were much less mobile. Prior to the end of World War I, global trade was mainly structured by colonial relations but was fairly unregulated. There was a limited level of mobility of raw materials, parts, and finished products. Developments in transport technology in the shipping and rail sectors allowed for greater volumes and distances to be covered. After World War I, international trade became fairly regulated with impediments such as tariffs, quotas, and limitations to foreign ownership. Trade mainly concerned a range of specific products, namely commodities (and very few services) that were not readily available in regional economies. Due to regulations, protectionism, and relatively high transportation costs, trade remained limited and delayed by inefficient freight distribution. It was challenging to coordinate production and distribution. In this context, trade was more an exercise to cope with scarcity than to promote economic efficiency.
  • Second phase (mobility of factors of production). From the 1970s to the 1990s, the mobility of factors of production, particularly capital, became possible. The legal and physical environment in which international trade was taking place leads to a better realization of the comparative advantages of specific locations. Concomitantly, regional trade agreements emerged, and the global trade framework was strengthened from a legal and transactional standpoint (GATT/WTO). In addition, containerization provided the capabilities to support more complex, and long-distance trade flows, as did the growing air traffic. Due to high production (legacy) costs in old industrial regions, activities that were labor-intensive were gradually relocated to lower costs locations; offshoring. The process began as a national one, then went to nearby countries when possible and afterward became a truly global phenomenon. Thus, foreign direct investments surged, particularly towards new manufacturing regions, as multinational corporations became increasingly flexible in the global positioning of their assets. The trade of finished and intermediate goods surged.
  • Third phase (global value chains). There is a growth in international trade, now including a wide variety of services that were previously fixed to regional markets and a surge in the mobility of the factors of production. Since these trends are well established, the priority is now shifting to the geographical and functional integration of production, distribution, and consumption with the emergence of global value chains. Complex networks involving flows of information, commodities, parts, and finished goods have been set, which in turn demands a high level of command of logistics and freight distribution. In such an environment, powerful actors have emerged which are not directly involved in the function of production and retailing, but mainly taking the responsibility of managing the web of flows. International trade becomes increasingly supported by digital technologies allowing for more efficient transactions, compliance to regulations and the management of the transportation and logistics assets supporting trade.

The global economic system is thus characterized by a growing level of integrated services, finance, retail, manufacturing, and distribution. This is mainly the outcome of improved transport and logistics, more efficient exploitation of regional comparative advantages, and a transactional environment supportive of the legal and financial complexities of global trade. International trade requires a full array of services related to distribution and transactions. The volume of exchanged goods and services between nations is taking a growing share of the generation of wealth, mainly by offering economic growth opportunities in new regions and by reducing the costs of a wide array of manufacturing goods. By 2007, international trade surpassed for the first time 50% of global GDP, a twofold increase in its share since 1950.

3. Trade Costs and Facilitation

The facilitation of trade involves how the procedures regulating the international movements of goods can be improved so that actors involved in international trade have move efficient formalities. For regulatory authorities, trade facilitation improves their effectiveness as well as reducing the risk of customs duty evasion. It relies on the reduction of the general costs of trade, which considers transaction, tariff, transport, and time costs. These trade costs are derived from two main sources:

  • Separation factors. These are usually exogenous factors separating two trade partners, such as distance, transportation costs, travel time, as well as common attributes shared by trade partners. These usually involve being part of an economic agreement (e.g. a free trade zone), which is facilitated when partners have a common boundary.
  • Country specific factors. Relates endogenous to factors that are either related to the origin or the destination of trade. This usually involves customs procedures (tariffs and non-tariff), the overall performance of the national transport and logistics sector, and how well an economy is connected to the international transport system through its gateways (mostly ports and airports).

United Nations estimates have underlined that for developing countries, a 10% reduction in transportation cost could be accompanied by a growth of about 20% in international and domestic trade. Thus, the ability to compete in a global economy is dependent on the transport system as well as a trade facilitation framework that includes measures related to economic integration, the capabilities of international transportation systems, and the ease to negotiate and settle transactions.

The quality, cost, and efficiency of trade services influence the trading environment as well as the overall costs linked with the international trade of goods. Many factors have been conductive to trade facilitation in recent decades, including integration processes, standardization, production systems, transport efficiency, and transactional efficiency:

  • Integration processes, such as the emergence of economic blocks and the decrease of tariffs at a global scale through agreements, promoted trade as regulatory regimes were harmonized. One straightforward measure of integration relates to custom delays, which can be a significant trade impediment since it adds uncertainty in supply chain management. The higher the level of economic integration, the more likely the concerned elements are to trade. International trade has consequently been facilitated by a set of factors linked with growing levels of economic integration, the outcome of processes such as the European Union or the North American Free Trade Agreement. The transactional capacity is consequently facilitated with the development of transportation networks and the adjustment of trade flows that follows increased integration. Integration processes have also taken place at the local scale with the creation of free zones where an area is given a different governance structure in order to promote trade, particularly export-oriented activities. In this case, the integration process is not uniform, as only a portion of an area is involved. China is a salient example of the far-reaching impacts of the setting of special economic zones operating under a different regulatory regime.
  • Standardization concerns the setting of a common and ubiquitous frame of reference over information and physical flows. Standards facilitate trade since those abiding by them benefit from reliable, interoperable, and compatible goods and services, which often results in lower production, distribution, and maintenance costs. Measurement units were among the first globally accepted standards (metric system), and the development of information technologies eventually led to common operating and telecommunication systems. It is, however, the container that is considered to be the most significant international standard for trade facilitation. By offering a load unit that can be handled by any mode and terminal with the proper equipment, access to international trade is improved.
  • Production systems are more flexible and embedded. It is effectively productive to maintain a network of geographically diversified inputs, which favors exchanges of commodities, parts, and services. Information technologies have played a role by facilitating transactions and the management of complex business operations. Foreign direct investments are commonly linked with the globalization of production as corporations invest abroad in search of lower production costs and new markets. China is a leading example of such a process, which went on par with the growing availability of goods and services that can be traded on the global market.
  • Transport efficiency has increased significantly because of innovations and improvements in the modes and infrastructures in terms of their capacity and throughput. Ports are particularly important in such a context since they are gateways to international trade through maritime shipping networks. As a result, the transferability of commodities, parts, and finished goods has improved. Decreasing transport costs does more than increasing trade; it can also help change the location of economic activities. Yet, transborder transportation issues remain to be better addressed in terms of capacity, efficiency, and security.
  • Transactional efficiency. The financial sector also played a significant role in integrating global trade, namely by providing investment capital and credit for international commercial transactions. For instance, a letter of credit may be issued based upon an export contract. An exporter can thus receive a payment guarantee from a bank until its customer finalizes the transaction upon delivery. This is particularly important since the delivery of international trade transactions can take several weeks due to the long distances involved. Recent efforts towards the digitalization of supply chains are further pushing towards higher levels of transactional efficiency. During a transfer, it is also common that the cargo is insured in the event of damage, theft, or delays, a function supported by insurance companies. Also, global financial systems permit to convert currencies according to exchange rates that are commonly set by market forces, while some currencies, such as the Chinese Yuan, are influenced by policy. Monetary policy can thus be a tool, albeit contentious, used to influence trade.

All these measures are expected to promote the level of economic and social development of the concerned nations since trade facilitation relies on the expansion of human, infrastructure, and institutional capabilities.

4. Global Trade Flows

The nature of what can be considered international trade has changed, particularly with the emergence of global value chains and the trade of intermediary goods they involve. This trend obviously reflects the strategies of multinational corporations positioning their manufacturing assets in order to lower costs and maximize new market opportunities. About 80% of the global trade takes place within value chains managed by multinational corporations. International trade has thus grown at a faster rate than global merchandise production, with the growing complexity of distribution systems supported by supply chain management practices. The structure of global trade flows has shifted, with many developing economies having growing participation in international trade with an increasing share of manufacturing.

Globalization has been accompanied by growing flows of manufactured goods and their growing share of international trade. The trend since the 1950s involved a relative decline in bulk liquids (such as oil) and more dry bulk and general cargo being traded. Recently, the share of fuels in international trade has increased, mainly due to rising energy demand and prices. Another emerging trade flow concerns the increase in the imports of resources from developing economies, namely energy, commodities, and agricultural products, which is a divergence from their conventional role as exporters of resources. This is indicative of economic diversification as well as increasing standards of living. However, significant fluctuations in the growth rates of international trade are linked with economic cycles of growth and recession, fluctuations in the price of raw materials, as well as disruptive geopolitical and financial events.

The geography of international trade remains dominated by a few large economic blocs, mainly in North America, Europe, and East Asia, which are commonly referred to as the triad. Alone, the United States, Germany, and Japan account for about a quarter of all global trade, with this supremacy being seriously challenged by emerging economies. Further, G7 countries account for half of the global trade, a dominance that has endured for over 100 years. A growing share is being accounted for by the developing economies of Asia, with China accounting for the most significant growth both in absolute and relative terms. Those geographical and economic changes are also reflected in trans-oceanic trade, with the Trans-Pacific trade growing faster than the Trans-Atlantic trade.

Neo-mercantilism is reflective of global trade flows as several countries have been actively pursuing export-oriented economic development policies using infrastructure development, subsidies, and exchange rates as tools. This strategy has been followed by developing economies and is associated with growing physical and capital flow imbalances in international trade. This is particularly reflective in the American container trade structure, which is highly imbalanced and having acute differences in the composition of imports and exports. A large share of these imbalances was the outcome of the fiscal policies of exporting countries purchasing American financial instruments, such as bonds. This enabled the US dollar to uphold its value and purchasing power.

Imbalances can also be misleading as products are composed of parts manufactured in several locations with assembly often taking place in low-cost locations and then exported to major consumption markets. In international trade statistics, a location assumes the full value of finished goods imported elsewhere while it may have only contributed to a small share of the total added value. Electronic devices are illustrative of this issue. Trade imbalances also do not reflect well the utility an economy derive from it, such as cheaper goods for consumers. Further, the growth of e-commerce has resulted in new actors to be involved in international trade, at times indirectly. For instance, ordering a product online may result in an international trade transaction controlled by a single corporation.

Regionalization has been one of the dominant features of global trade as the bulk of trade has a regional connotation, promoted by proximity and the setting of economic blocs such as NAFTA and the European Union. The closer economic entities are, the more likely they are to trade due to lower transport costs, fewer potential delays in shipments, common customs procedures, and linguistic and cultural affinities. The most intense trade relations are within Western Europe and North America, with a more recent trend involving trade within Asia, particularly between Japan, China, Korea, and Taiwan as these economies were getting more integrated.

5. Global Trade at a Threshold?

At the beginning of the 21st century, the flows of globalization have been shaped by four salient trends:

  • The ongoing growth of international trade, both in absolute terms and in relation to global national income, a growth that appears to be leveling off. From 1980 to 2015 the value of exports has grown by a factor of 9 times if measured in current dollars, while GDP increased 6 times and the population increased 1.6 times. Since the 2010s, international trade appears to be leveling.
  • A substantial level of containerization of commercial flows, with container throughput growing in proportion with global trade. Containerization tends to grow at a rate faster than that of trade and GDP. This has been associated with the setting of intermodal transport chains connecting exporters and importers.
  • A higher relative growth of trade of emerging economies, particularly in Pacific Asia that focus on export-oriented development strategies that have been associated with imbalances in commercial relations.
  • The growing role of multinational corporations as vectors for international trade, particularly in terms of the share of international trade taking place within corporations and the high level of concentration of their head offices.

Still, many challenges are impacting future developments in international trade and transportation, mostly in terms of demographics, political, supply chain, energy, and environmental issues. While the global population and its derived demand will continue to grow and reach around 9 billion by 2050, demographic changes such as the aging of the population, particularly in developed economies, will transform consumption patterns as a growing share of the population shifts from wealth-producing (working and saving) to wealth consuming (selling saved assets). Demographic trends in North America, Europe, and East Asia (e.g. Japan, South Korea, Taiwan) may not place them as drivers of global trade, a function they have assumed in recent decades. The demographic dividend in terms of peak share of the working-age population that many countries benefited from, particularly China, will recede.

The regulatory environment and the involvement of governments, either directly or indirectly, is subject to increasing contention. Reforms in agricultural trade have not been effectively carried on, implying that many governments (e.g. in the EU) provide high subsidy levels to their agricultural sectors, undermining the competitiveness of foreign agricultural goods. This is undertaken with the intent to protect their agriculture, considering the risks associated with dependency on foreign providers and possible fluctuations in prices. Intellectual property rights remain a contentious issue as well since many goods are duplicated, undermining the brands of major manufacturers and retailers. There is also a whole array of subsidies that influence the competitiveness of exports, such as low energy and land costs and tax reductions. The rise of protectionist policies, as exemplified by higher tariffs imposed by the American government on several Chinese goods, is underlining a contentious trade environment.

As both maritime and air freight transportation depend on petroleum, international trade remains influenced by fluctuations in energy prices. The paradox has become that periods of high energy prices usually impose a rationalization of international trade and its underlying supply chains. However, periods of low or sharply declining energy prices, which should benefit international transportation, are linked with economic recessions. Environmental issues have also become more salient with the growing tendency of the public sector to regulate components of international transportation that are judged to have negative externalities. International trade enables several countries to mask their energy consumption and pollutant emissions by importing goods that are produced elsewhere and where environmental externalities are generated. Thus, international trade has permitted a shift in the international division of production, but also a division between the generation of environmental externalities and the consumption of the goods related to these externalities.

Technological changes are impacting the nature of manufacturing systems through robotization and automation. The fourth industrial revolution is changing input costs, particularly labor. Since a good share of international trade is the result of the convenience of comparative advantages, automation and robotization can undermine the standard advantages of lower labor costs and make manufacturing more productive at other locations, such as those closer to major markets. Further, since many developing economies remain complex places to undertake business as state and national firms are privileged, the loss of labor cost advantages could undermine future development prospects. This is likely to have a strong influence on the nature and volume of international trade, which could level and even regress. If this is the case, absolute advantages, such as resources, would play a greater influence on trade, as was the case before the 1970s.


Related Topics

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