Trade refers to the voluntary exchange of goods or services between different economic actors. Since the parties are under no obligation to trade, a transaction will only occur if both parties consider it beneficial to their interests.
Trade can have more specific meanings in different contexts. In financial markets, trade refers to the purchase and sale of securities, commodities, or derivatives. Free trade means international exchanges of products and services, without obstruction by tariffs or other trade barriers.
KEY TAKEAWAYS
- Trade refers to the voluntary exchange of goods or services between economic actors.
- Since transactions are consensual, trade is generally considered to benefit both parties.
- In finance, trading refers to the purchase and sale of securities or other assets.
- In international trade, the theory of comparative advantage predicts that trade is beneficial to all parties.
- Most classical economists advocate for free trade, but some development economists believe there are advantages to protectionism.
Economic Trade
How Trade Works
As a generic term, trade can refer to any type of voluntary exchange, from the exchange of baseball cards between collectors to multimillion-dollar contracts between companies.
Used in macroeconomics, trade usually refers to international trade, the system of exports and imports that connects the global economy. A product that is sold to the global market is an export, and a product that is bought from the global market is an import. Exports can account for a major source of wealth for well-connected economies.
International trade not only results in increased efficiency but also allows countries to benefit from foreign direct investment (FDI) by businesses in other countries. FDI can bring foreign currency and expertise into a country, raising the local employment and skill levels. For the investor, FDI offers company expansion and growth, eventually leading to higher revenues.
A trade deficit is a situation where a country spends more on aggregate imports from abroad than it earns from its aggregate exports. A trade deficit represents an outflow of domestic currency to foreign markets. This may also be referred to as a negative balance of trade (BOT).
Benefits of Trade
Because countries are endowed with different assets and natural resources, some countries may produce the same good more efficiently and therefore sell it more cheaply than other countries. Countries that trade can take advantage of the lower prices available in other countries.
This principle, commonly known as the Law of Comparative Advantage, is popularly attributed to English political economist David Ricardo and his book On the Principles of Political Economy and Taxation in 1817. However, it is likely that Ricardo’s mentor James Mill originated the analysis.
$28.5 trillion
The total value of the global trading market, according to the United Nations.1
Ricardo famously showed how England and Portugal both benefit by specializing and trading according to their comparative advantages. In this case, Portugal was able to make wine at a low cost, while England was able to manufacture cloth cheaply. By focusing on their comparative advantages, both countries could consume more goods through trade than they could in isolation.
The theory of comparative advantage helps to explain why protectionism is often counterproductive. While a country can use tariffs and other trade barriers to benefit certain industries or interest groups, these policies also prevent their consumers from the benefits of cheaper goods from abroad. Eventually, that country would be at an economic disadvantage relative to countries that do trade.
Criticisms of Trade
While the law of comparative advantage is a regular feature of introductory economics, many countries nonetheless try to shield local industries with tariffs, subsidies, or other trade barriers. . One possible explanation comes from what economists call rent-seeking. Rent-seeking occurs when one group organizes and lobbies the government to protect its interests.
For example, business owners might pressure their country’s government for tariffs to protect their industry from inexpensive foreign goods, which could cost the livelihoods of domestic workers. Even if the business owners understand the benefits of trade, they could be reluctant to sacrifice a lucrative income stream.
Moreover, there are strategic reasons for countries to avoid excessive reliance on free trade. For example, a country that relies on trade might find itself dependent on the global market for key goods.
Some development economists have argued for tariffs as a way to help protect infant industries that cannot yet compete on the global market. As those industries move up the learning curve, they are expected to reach the point of becoming a comparative advantage.
How Does the WTO Promote Global Free Trade?
The World Trade Organization (WTO) is an intergovernmental institution that supervises and enforces trade agreements between different countries. Its main purpose is to help mediate or adjudicate disputes between countries alleging unfair trade practices. For example, if one country’s laws make it difficult to sell foreign products in that country, the WTO might be called upon to settle the dispute.
Is Trade Good for Jobs?
There are winners and losers in international trade because some industries benefit from global prices and others will struggle to compete. Overall, since trade allows businesses and consumers to access the best prices and redirect the savings to other economic activities, trade is expected to be a net benefit for employment in most cases.
How Much Does the US Trade With Other Countries?
In 2021, the U.S. imported about $2.83 trillion worth of goods from international markets, and exported goods worth about $1.75 trillion.2