Syllabus A. Role Of The Senior Financial Adviser A4. Management of international trade and finance

A4ab. Free trade and the management of barriers to trade 1 / 11

Syllabus A4ab)

a) Advise on the theory and practice of free trade and the management of barriers to trade.

b) Demonstrate an up to date understanding of the major trade agreements and common markets and, on the basis of contemporary circumstances, advise on their policies and strategic implications for a given business.

Free trade

Practical reasons for overseas trade

  1. Choice

    The diversity of goods available in a domestic economy is increased through the import of goods that could be uneconomic or impossible to produce at home (e.g. oil).

  2. Competition

    International trade will increase competition in domestic markets, which is likely to lead to both a reduction in price, together with increasing pressure for new products and innovation.

  3. Economies of scale

    By producing both for the home and international markets companies can produce at a larger scale and therefore take advantage of economies of scale.

  4. Specialisation

    If a country specialises in producing the goods and services at which it is most efficient, it can maximise its economic output.

Trade barriers (Protectionism)

There are a number of ways that a country can seek to restrict imports. 

Trade barriers include:

  • Quotas

    – a restriction on the number of items that are allowed to be imported

    e.g. quotas on the number of cars manufactured outside of Europe that can be imported into the EU.

  • Tariffs

    – imposition of an import tax on goods being imported
    – making imported goods relatively more expensive compared to domestically produced goods

  • Exchange controls

     – domestic companies wishing to buy foreign goods will have to pay in the currency of the exporter’s country. 

    To do this they will need to buy the currency involved by selling sterling. 

    If the government controls the sale of sterling it can control the level of imports purchased.

  • Administrative controls

     – a domestic government can subject imports to excessive levels of administration, paperwork and red tape to slow down and increase the cost of importing goods into the home economy.

    eg increasing the safety standards that imported goods must comply with

  • Embargoes

    – the prohibition of commerce and trade with a certain country.

  • Ban on Import

    An outright ban on imports (or on imports of certain products)

  • Subsidies

    Offering subsidies to domestic producers

Multinational companies have to find ways of overcoming these barriers.

For example by investing directly and manufacturing within a country rather than importing into it.

Free trade - problems

In reality, many countries try to protect local companies and to improve their balance of payments by reducing imports. 

Sometimes there is an argument that foreign competition is not appropriate because:

  • Imported products are being sold below production cost to destroy domestic firms (this is called dumping)

  • Domestic firms are new and are too small to be able to compete against larger foreign rivals yet, and so need protecting from them (sometimes called the infant industry argument)

  • Some industries must not be allowed to be driven out of existence by foreign rivals because they have a long-term strategic importance to the country

    eg shipbuilding

  • Some countries have an unfair advantage because they don't pay the social costs of production (eg decent wages and working conditions)

Trade agreements and common markets

In many parts of the world, governments have created trade agreements and common markets to encourage free trade. 

However, the World Trade Organisation (WTO) is opposed to these trading blocs and customs unions (e.g. the European Union) because they encourage trade between members but often have high trade barriers for non-­members.