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Information > Financial Terms > This page Foreign Trade Trade among nations is a common occurrence and normally benefits both the exporter and the importer. In many countries international trade accounts for more than 20 percent of their national incomes. Foreign trade can usually be justified on the principle of comparative advantage. According to this economic principle, it is economically profitable for a country to specialize in the production of that commodity in which the producer country has the greater comparative advantage and to allow the other country to produce that commodity in which it has the lesser comparative disadvantage. For example, a doctor should practice medicine in which he specialized instead of performing office typing tasks because the doctor has a greater comparative advantage over a typist in this situation; the typist should perform that service in which she has the lesser comparative disadvantage (typing). Economists generally maintain that the risks of foreign trade increase as a company moves from exporting to direct foreign investment and when its activities are directed to less developed countries rather than to developed countries. Major obstacles to international trade include tariffs imposed upon imports. A tariff is a duty or tax levied on foreign imports. Tariffs are usually specific tariffs ($30 per pound of a commodity) or ad valorem tariffs (15 percent of the value of the imported commodity). Tariffs are usually imposed to provide revenue or to protect a home industry. These two objectives are normally incompatible. Arguments suggested to support free (or freer) trade include the following: tariffs deny individuals and nations the benefits of greater productivity and a higher standard of living; tariffs eliminate or reduce the advantages of specialization and exchange among nations and prevent the best use of scare world resources. Basic arguments for tariffs are grouped as follows: 1. Protect infant industries. 2. Equalize costs of production between domestic and foreign producers. 3. Protect U.S. jobs. 4. Protect high W.S. wages. 5. Keep money at home. 6. Develop and protect defense industries. Import quotas are also used to set the maximum absolute amount of a particular commodity that can be imported. Export subsidies are used to encourage exportation of certain goods or to prevent discrimination against U.S. exporters who sell in a foreign market at a world price lower than the domestic price. Exchange controls are also used to control the flow of international trade. Some controls are used to ration a country's scarce foreign exchange. Some countries use different exchange rates for different commodities to encourage or discourage imports. The United States has granted tariff concessions on thousands of commodities (automobiles, steel, chemicals) to promote world trade as well as economic and political harmony. The Trade Act of 1974 gave the President a wide range of measures that could be used to open trade doors around the world. This Act also allowed the president to extend most-favored-nation treatment to various nations. The United States and other nations have organized international financial institutions to provide various forms of foreign aid. The International Bank for Reconstruction and Development (the World Bank) is intended "to supplement private investments in foreign countries by nations and individuals having capital to lend." The World Bank issues and sells bonds and uses the proceeds for loans to "any business, industrial, or agricultural enterprise in the territory of a member," and guarantees loans by private investors. The major purpose of the World Bank is to stimulate world production, trade, and investment. The International Finance Corporation (IFC) is affiliated with the World Bank. The IFC attempts to stimulate economic development by encouraging the growth of private productive enterprises, especially in lesser developed areas. It can invest in private enterprises but without government guarantees of repayment. The International Development Administration, also affiliated with the World Bank, was organized to allow underdeveloped nations to borrow funds. The Inter-American Development Bank was organized to stimulate the economic development of the Latin American nations. The United States makes major contributions to these international organizations. Foreign financing sources for international trade transactions include commercial bank loans within the host country and loans from international lending agencies. Foreign banks can also be used to discount trade bills to finance short term financing. Eurodollar financing is another method for providing foreign financing. A Eurodollar is a dollar deposit held in a bank outside the United States. An active market exists for these deposits. Banks use Eurodollars to make dollar loans to borrowers; the interest rate is usually in excess of the deposit rate. Such loans are usually in very large amounts, are short-term working-capital loans, and are unsecured. U.S. firms frequently arrange for lines of credit and revolving credits from Eurodollar banks. No compensating balances are usually required. The Eurobond market is widely used for long-term funds for multinational U.S. companies. A Eurobond is a long-term security issued by an internationally recognized borrower in several countries simultaneously. The bonds are denominated in a single currency. Such bonds are usually fixed-income bonds or floating-rate bonds; some bonds are convertible into common stock. Many countries have organized development banks that provide intermediate- and long-term loans to private enterprises. Such loans are made to provide economic development within a country. The Export-Import Bank (Exim Bank) is an independent agency of the U.S. government organized to facilitate the financing of exports from the United States. It makes long-term loans to foreigners, enabling such parties to purchase U.S. goods and services. The bank often participates with private lenders in extending credit and guarantees payment of medium-term financing incurred in the export of U.S. goods and services. International trade procedures differ in some respects from those used in domestic trade. Three key documents include the trade draft (an order to pay); a bill of lading (a shipping document used in transporting goods from the exporter to the importer); and a letter of credit (issued by a bank on behalf of the importer to guarantee the creditworthiness of the purchaser). The trade draft, or bill of exchange, is a written statement (an unconditional order) by the exporter ordering the importer to pay a specific amount of money at a specific time. A sight draft is payable on presentation to the party to whom the draft is addressed (the drawee). A time draft is payable a certain number of days after presentation to the drawee. If the draft is accepted by the drawee, it represents a trade acceptance. If a bank accepts the draft, it is referred to as a bankers' acceptance; such instruments are highly marketable. The bill of lading gives the holder title to the goods. The bill of lading accompanies the draft. U.S. citizens, residents aliens, and domestic corporations generally receive the same tax treatment for the income they earn. U.S. citizens who work in foreign countries for extended periods of time are provided a special exception. Currently, such individuals can exclude up to $70,000 of income earned from performing personal services in foreign countries. A U.S. citizen satisfied the bona fide resident test if the individual (1) has been a resident of a foreign country for an uninterrupted period which includes an entire tax year and (2) has maintained a tax home in a foreign country during the period of residence. Generally, nonresident aliens and foreign corporations are taxed only on their U.S. investment income. However, if such parties conduct a trade or business in the United States at some time during the year, the parties are taxed on both their U.S. investment income and their income that is attributable to the conduct of the U.S. trade or business. A foreign tax credit permits U.S. taxpayers to avoid double taxation by crediting income taxes paid or accrued to (1) a foreign country or (2) a U.S. possession against the U.S. tax liability. Certain conditions and limitations are imposed. Appended is a table showing the top 10 U.S. trading partners in manufactured goods in 1986. A second appended table shows foreign trade of the United States (in million of dollars). Since 1970 there has been a sharp rise and dramatic decline in the rate of U.S. foreign direct investment (see appended table). U.S. foreign investment grew at a compound annual rate of 10.4% in the 1970-1974 period and at 12.0% in the 1975-1979 period. The growth was due to the increasing development of petroleum resources and the stagnating U.S. economy. From 1980-1985, the rate declined to 3.6%. This decline was attributed in part to the wide differential in interest rates favoring capital markets in the U.S. In 1970 developed countries received 69% of U.S. foreign investment; less developed countries received 25%. At the end of 1985, U.S. investment was proportioned with 74% in developed countries and 23% in less developed countries. In 1989 the Commerce Department reported that U.S. debt to the rest of the world rose sharply to $532.5 billion which made the U.S. the world's largest debtor. The debt at the end of 1988 was 40% greater than the $378.3 billion reported for 1987. Foreigners' assets in the U.S. increased 15.4% to $1.786 trillion while U.S. assets overseas grew only 7.2 % to $1.254 trillion. The U.S. began the 1980s as a large creditor but became a debtor nation in 1985. A deficiency of U.S. savings forced the U.S. to borrow from abroad to finance investments. Foreign direct investment in factories and companies in the U.S. reached a record $57.1 billion, representing a 21% increase for the year. Britain and Japan accounted for approximately three-fourths of the increase. Foreign holdings of Treasury securities increased almost 19% to $96.6 billion in 1988. The Commerce Department reported that borrowing by U.S. banks from foreign offices to meet strong domestic loan demand pushed up bank liabilities to foreigners by 11.3% to $609.5 billion. Approximately three quarters of U.S. direct investment abroad is in developed countries. In 1988, Britain and Japan reflected the largest increase in direct investment with $48 billion and $16.9 billion, respectively. BIBLIOGRAPHY Foreign Trade & Tariff. U.S. Superintendent of Documents (Subject bibl. 123). KINGMAN-BRUNDAGE, J., and SCHULZ, S.A. The Fundamentals of Trade Finance, 1986. INTERNATIONAL CHAMBER OF COMMERCE, Publication No. 400. Uniform Customs and Practices for Documentary Credits, 1983. Publication 322 Uniform Rules for Collections. Publication 325 Uniform Rules for Contract Guarantees. Publication 365 Introduction to I.C.C. Rules on International Contracts. Publication 417 Key Words in International Trade. |