Comparative Advantage and the Gains From Trade

comparative advantage and the gains from
trade
There are potentially many gains in economic welfare to be achieved through free trade:
Greater choice of products for consumers
Increased competition for producers
Other countries can supply certain products more efficiently
Trade speeds up the pace of technological progress and innovation
Businesses are better placed to exploit economies of scale
Political benefits from expansion of global trade
The theory of comparative advantage can show these gains from trade
In economics, comparative advantage refers to the ability of a party to produce a particular
good or service at a lower marginal and opportunity cost over another. Even if one country is
more efficient in the production of all goods (absolute advantage in all goods) than the other,
both countries will still gain by trading with each other, as long as they have different relative
efficiencies.
[1][2][3]

For example, if, using machinery, a worker in one country can produce both shoes and shirts at 6
per hour, and a worker in a country with less machinery can produce either 2 shoes or 4 shirts in
an hour, each country can gain from trade because their internal trade-offs between shoes and
shirts are different. The less-efficient country has a comparative advantage in shirts, so it finds it
more efficient to produce shirts and trade them to the more-efficient country for shoes. Without
trade, its opportunity cost per shoe was 2 shirts; by trading, its cost per shoe can reduce to as low
as 1 shirt depending on how much trade occurs (since the more-efficient country has a 1:1 trade-
off). The more-efficient country has a comparative advantage in shoes, so it can gain in
efficiency by moving some workers from shirt-production to shoe-production and trading some
shoes for shirts. Without trade, its cost to make a shirt was 1 shoe; by trading, its cost per shirt
can go as low as 1/2 shoe depending on how much trade occurs.
n economics, the principle of absolute advantage refers to the ability of a party (an individual,
or firm, or country) to produce more of a good or service than competitors, using the same
amount of resources.
[1][2][3][4][5][6]
Adam Smith first described the principle of absolute advantage
in the context of international trade, using labor as the only input.
Since absolute advantage is determined by a simple comparison of labor productivities, it is
possible for a party to have no absolute advantage in anything;
[7]
in that case, according to the
theory of absolute advantage, no trade will occur with the other party.
[8]
It can be contrasted with
the concept of comparative advantage which refers to the ability to produce a particular good at a
lower opportunity cost.
In economics, gains from trade refers to net benefits to agents from allowing an increase in voluntary
trading with each other.
 Absolute advantage refers to being more efficient at performing a task. To use the above
example, women apparently have an absolute advantage in ironing because they can iron more
shirts in three minutes than men can.
 Comparative advantage, on the other hand, refers to being able to complete a task at a lower
opportunity cost than others.
free trade has come to mean the conduct of international business without any governmental
interference, such as tariffs, quotas, subsidies,
Features of free trade
Free trade implies the following features:
[citation needed]

 Trade of goods without taxes (including tariffs) or other trade barriers (e.g., quotas on imports
or subsidies for producers)
 Trade in services without taxes or other trade barriers
 The absence of "trade-distorting" policies (such as taxes, subsidies, regulations, or laws) that
give some firms, households, or factors of production an advantage over others
 Unregulated access to markets
 Unregulated access to market information
 Inability of firms to distort markets through government-imposed monopoly or oligopoly power
According to Prof. Don Boudreaux, free trade is nothing more than a system of trade that treats foreign
goods and services no differently than domestic goods and services. Protectionism, on the other hand, is
a system of trade that discriminates against foreign goods and services in an attempt to favor domestic
goods and services. In theory, free trade outperforms protectionism by bringing lower cost goods and
services to consumers. In practice, the benefits of free trade can be seen in countries like America and
Hong Kong. Both countries have a relatively high degree of free trade, and, as a consequence, have
experienced an explosion of wealth.
Protectionism is the economic policy of restraining trade between states through methods such
as tariffs on imported goods, restrictive quotas, and a variety of other government regulations
designed to allow (according to proponents) "fair competition" between imports and goods and
service produced domestically.
[1]

This policy contrasts with free trade, where government barriers to trade are kept to a minimum.
In recent years, it has become closely aligned with anti-globalization. The term is mostly used in
the context of economics, where protectionism refers to policies or doctrines which protect
businesses and workers within a country by restricting or regulating trade with foreign nations
Protectionist policies
A variety of policies have been used to achieve protectionist goals. These include:
1. Tariffs: Typically, tariffs (or taxes) are imposed on imported goods. Tariff rates usually vary
according to the type of goods imported. Import tariffs will increase the cost to importers, and
increase the price of imported goods in the local markets, thus lowering the quantity of goods
imported, to favour local producers. (see Smoot–Hawley Tariff Act) Tariffs may also be imposed
on exports, and in an economy with floating exchange rates, export tariffs have similar effects as
import tariffs. However, since export tariffs are often perceived as 'hurting' local industries,
while import tariffs are perceived as 'helping' local industries, export tariffs are seldom
implemented.
2. Import quotas: To reduce the quantity and therefore increase the market price of imported
goods. The economic effects of an import quota is similar to that of a tariff, except that the tax
revenue gain from a tariff will instead be distributed to those who receive import licenses.
Economists often suggest that import licenses be auctioned to the highest bidder, or that import
quotas be replaced by an equivalent tariff.
3. Administrative barriers: Countries are sometimes accused of using their various administrative
rules (e.g. regarding food safety, environmental standards, electrical safety, etc.) as a way to
introduce barriers to imports.
4. Anti-dumping legislation: Supporters of anti-dumping laws argue that they prevent "dumping"
of cheaper foreign goods that would cause local firms to close down. However, in practice, anti-
dumping laws are usually used to impose trade tariffs on foreign exporters.
5. Direct subsidies: Government subsidies (in the form of lump-sum payments or cheap loans) are
sometimes given to local firms that cannot compete well against imports. These subsidies are
purported to "protect" local jobs, and to help local firms adjust to the world markets.
6. Export subsidies: Export subsidies are often used by governments to increase exports. Export
subsidies have the opposite effect of export tariffs because exporters get payment, which is a
percentage or proportion of the value of exported. Export subsidies increase the amount of
trade, and in a country with floating exchange rates, have effects similar to import subsidies.
7. Exchange rate manipulation: A government may intervene in the foreign exchange market to
lower the value of its currency by selling its currency in the foreign exchange market. Doing so
will raise the cost of imports and lower the cost of exports, leading to an improvement in its
trade balance. However, such a policy is only effective in the short run, as it will most likely lead
to inflation in the country, which will in turn raise the cost of exports, and reduce the relative
price of imports.
8. International patent systems: There is an argument for viewing national patent systems as a
cloak for protectionist trade policies at a national level. Two strands of this argument exist: one
when patents held by one country form part of a system of exploitable relative advantage in
trade negotiations against another, and a second where adhering to a worldwide system of
patents confers "good citizenship" status despite 'de facto protectionism'. Peter Drahos explains
that "States realized that patent systems could be used to cloak protectionist strategies. There
were also reputational advantages for states to be seen to be sticking to intellectual property
systems. One could attend the various revisions of the Paris and Berne conventions, participate
in the cosmopolitan moral dialogue about the need to protect the fruits of authorial labor and
inventive genius...knowing all the while that one's domestic intellectual property system was a
handy protectionist weapon."
[3]

9. Employment-based immigration restrictions, such as labor certification requirements or
numerical caps on work visas.
10. Political campaigns advocating domestic consumption (e.g. the "Buy American" campaign in the
United States, which could be seen as an extra-legal promotion of protectionism.)
11. Preferential governmental spending, such as the Buy American Act, federal legislation which
called upon the United States government to prefer U.S.-made products in its purchases.
Arguments for protectionism
Protectionists believe that there is a legitimate need for government restrictions on free trade in
order to protect their country’s economy and its people’s standard of living.
Infant industry argument
Main article: Infant industry argument
Protectionists believe that infant industries must be protected in order to allow them to grow to a
point where they can fairly compete with the larger mature industries established in foreign
countries. They believe that without this protection, infant industries will die before they reach a
size and age where economies of scale, industrial infrastructure, and skill in manufacturing have
progressed sufficiently to allow the industry to compete in the global market.
Criticisms of the Theory of Comparative Advantage as a basis for trade policy
According to Bitanica.com, "The theory of comparative advantage provides a strong argument in
favour of free trade and specialization among countries. The issue becomes much more complex,
however, as the theory’s simplifying assumptions—a single factor of production, a given stock
of resources, full employment, and a balanced exchange of goods—are replaced by more-
realistic parameters."
[11]

Protectionists argue that comparative advantage has lost its legitimacy in a globally integrated
world in which capital is free to move internationally. Herman Daly, a leading voice in the
discipline of ecological economics, emphasizes that although Ricardo's theory of comparative
advantage is one of the most elegant theories in economics, its application to the present day is
illogical: "Free capital mobility totally undercuts Ricardo's comparative advantage argument for
free trade in goods, because that argument is explicitly and essentially premised on capital (and
other factors) being immobile between nations. Under the new global economy, capital tends
simply to flow to wherever costs are lowest—that is, to pursue absolute advantage."
[12]

Protectionists would point to the building of plants and shifting of production to Mexico by
American companies such as GE, GM, and Hershey Chocolate as proof of this argument.
Domestic tax policies can favor foreign goods
Protectionists believe that allowing foreign goods to enter domestic markets without being
subject to tariffs or other forms of taxation, leads to a situation where domestic goods are at a
disadvantage, a kind of reverse protectionism. By ruling out revenue tariffs on foreign products,
governments must rely solely on domestic taxation to provide its revenue, which falls
disproportionately on domestic manufacturing. As Paul Craig Roberts notes: "Foreign
discrimination of US products is reinforced by the US tax system, which imposes no appreciable
tax burden on foreign goods and services sold in the US but imposes a heavy tax burden on US
producers of goods and services regardless of whether they are sold within the US or exported to
other countries."
[13]

Protectionists argue that this reverse protectionism is most clearly seen and most detrimental to
those countries (such as the US) that do not participate in the Value Added Tax (VAT) system.
This is a system which generates revenues from taxation on the sale of goods and services,
whether foreign or domestic. Protectionists argue that a country that does not participate is at a
distinct disadvantage when trading with a country that does. That the final selling price of a
product from a non-participating country sold in a country with a VAT tax must bear not only
the tax burden of the country of origin, but also a portion of the tax burden of the country where
it is being sold. Conversely, the selling price of a product made in a participating country and
sold in a country that does not participate, bears no part of the tax burden of the country in which
it is sold (as do the domestic products it is competing with). Moreover, the participating country
rebates VAT taxes collected in the manufacture of a product if that product is sold in a non-
participating country. According to Congressman Bill Pascrell, Jr., "Altogether, imports into the
U.S. face average tariffs of 1.3% and no VAT penalty, whereas U.S. exports face average tariffs
worldwide of about 40% plus VAT border adjustment penalty of 15.7%. In addition, foreign
companies get a VAT rebate when they export to the U.S. averaging 15.7%!"
[14]

Protectionists believe that governments should address this inequity, if not by adopting a VAT
tax, then by at least imposing compensating taxes (tariffs) on imports.
Unrestricted trade undercuts domestic policies for social good
Most industrialized governments have long held that laissez-faire capitalism creates social evils
that harm its citizens. To protect those citizens, these governments have enacted laws that restrict
what companies can and can not do in pursuit of profit. Examples are laws regarding:
 collective bargaining
 child labor
 competition (antitrust)
 environmental protection
 equal opportunity
 intellectual property
 minimum wage
 occupational safety and health
Protectionists argue that these laws, adding cost to production, place an economic burden on
domestic companies bound by them that put those companies at a disadvantage when they
compete, both domestically and abroad, with goods and services produced in countries without
such laws. They argue that governments have a responsibility to protect their corporations as
well as their citizens when putting its companies at a competitive disadvantage by enacting laws
for social good. Otherwise they believe that these laws end up destroying domestic companies
and ultimately hurting the citizens these laws were designed to protect.
Arguments against protectionism
Protectionism is frequently criticized by mainstream economists as harming the people it is
meant to help. Most mainstream economists instead support free trade.
[6][15]
Economic theory,
under the principle of comparative advantage, shows that the gains from free trade outweigh any
losses as free trade creates more jobs than it destroys because it allows countries to specialize in
the production of goods and services in which they have a comparative advantage.
[16]

Protectionism results in deadweight loss; this loss to overall welfare gives no-one any benefit,
unlike in a free market, where there is no such total loss. According to economist Stephen P.
Magee, the benefits of free trade outweigh the losses by as much as 100 to 1.
[17]

Most economists, including Nobel prize winners Milton Friedman and Paul Krugman, believe
that free trade helps workers in developing countries, even though they are not subject to the
stringent health and labour standards of developed countries. This is because "the growth of
manufacturing — and of the myriad other jobs that the new export sector creates — has a ripple
effect throughout the economy" that creates competition among producers, lifting wages and
living conditions.
[18]
Economists
[who?]
have suggested that those who support protectionism
ostensibly to further the interests of workers in least developed countries are in fact being
disingenuous, seeking only to protect jobs in developed countries.
[19]
Additionally, workers in
the least developed countries only accept jobs if they are the best on offer, as all mutually
consensual exchanges must be of benefit to both sides, or else they wouldn't be entered into
freely. That they accept low-paying jobs from companies in developed countries shows that their
other employment prospects are worse. A letter reprinted in the May 2010 edition of Econ
Journal Watch identifies a similar sentiment against protectionism from sixteen British
economists at the beginning of the 20th century.
[20]

Alan Greenspan, former chair of the American Federal Reserve, has criticized protectionist
proposals as leading "to an atrophy of our competitive ability. ... If the protectionist route is
followed, newer, more efficient industries will have less scope to expand, and overall output and
economic welfare will suffer."
[21]

Protectionism has also been accused of being one of the major causes of war. Proponents of this
theory point to the constant warfare in the 17th and 18th centuries among European countries
whose governments were predominantly mercantilist and protectionist, the American
Revolution, which came about ostensibly due to British tariffs and taxes, as well as the protective
policies preceding both World War I and World War II. According to a slogan of Frédéric
Bastiat (1801–1850), "When goods cannot cross borders, armies will."
[22]

Free trade promotes equal access to domestic resources (human, natural, capital, etc.) for
domestic participants and foreign participants alike. Some thinkers
[who?]
extend that under free
trade, citizens of participating countries deserve equal access to resources and social welfare
(labor laws, education, etc.). Visa entrance policies tend to discourage free reallocation between
many countries, and encourage it with others. High freedom and mobility has been shown to lead
to far greater development than aid programs in many cases, for example eastern European
countries in the European Union. In other words visa entrance requirements are a form of local
protectionism.

Some governments impose foreign exchange controls to influence the buying and selling of
currencies. Foreign exchange controls usually affect local residents who make transactions
involving foreign currencies and foreign residents who make transactions involving the local
currency. These governments usually aim to protect their own weak currencies, which people
often prefer to exchange for other, stronger currencies.
From 1870 to 1914, most countries fixed their currencies to gold; the central banks of these
countries conducted exchanges between gold and the local currencies. The gold standard
effectively also fixed the exchange rates between different currencies. In the early 1930s, many
countries abandoned the gold standard because of financial instabilities and excessive inflation
brought on by World War I. A system where the International Monetary Fund (IMF) supervised
various fixed exchange rates and adjusted them as necessary prevailed for almost two decades
after 1944. The current system involves floating exchange rates that mostly depend on the forces
demand and supply.
Foreign exchange controls are various forms of controls imposed by a government on the
purchase/sale of foreign currencies by residents or on the purchase/sale of local currency by
nonresidents.
Common foreign exchange controls include:
 Banning the use of foreign currency within the country
 Banning locals from possessing foreign currency
 Restricting currency exchange to government-approved exchangers
 Fixed exchange rates
 Restrictions on the amount of currency that may be imported or exported
Countries with foreign exchange controls are also known as "Article 14 countries," after the
provision in the International Monetary Fund agreement allowing exchange controls for
transitional economies. Such controls used to be common in most countries, particularly poorer
ones, until the 1990s when free trade and globalization started a trend towards economic
liberalization. Today, countries which still impose exchange controls are the exception rather
than the rule.
Often, foreign exchange controls can result in the creation of black markets to exchange the
weaker currency for stronger currencies. This leads to a situation where the exchange rate for the
foreign currency is much higher than the rate set by the government, and therefore creates a
shadow currency exchange market. As such, it is unclear whether governments have the ability
to enact effective exchange controls.
[1]


Exchange risk is the effect that unanticipated exchange rate changes have on the value of the
firm. This chapter explores the impact of currency fluctuations on cash flows, on assets and
liabilities, and on the real business of the firm. Three questions must be asked. First, what
exchange risk does the firm face, and what methods are available to measure currency exposure?
Second, based on the nature of the exposure and the firm's ability to forecast currencies, what
hedging or exchange risk management strategy should the firm employ? And finally, which of
the various tools and techniques of the foreign exchange market should be employed: debt and
assets; forwards and futures; and options. The chapter concludes by suggesting a framework that
can be used to match the instrument to the problem.
1 (b) What is exchange risk?
Exchange risk is simple in concept: a potential gain or loss that occurs as a result of an exchange
rate change. For example, if an individual owns a share in Hitachi, the Japanese company, he or
she will lose if the value of the yen drops.
Yet from this simple question several more arise. First, whose gain or loss? Clearly not just
those of a subsidiary, for they may be offset by positions taken elsewhere in the firm. And not
just gains or losses on current transactions, for the firm's value consists of anticipated future cash
flows as well as currently contracted ones. What counts, modern finance tells us, is shareholder
value; yet the impact of any given currency change on shareholder value is difficult to assess, so
proxies have to be used. The academic evidence linking exchange rate changes to stock prices is
weak.
Moreover the shareholder who has a diversified portfolio may find that the negative effect of
exchange rate changes on one firm is offset by gains in other firms; in other words, that exchange
risk is diversifiable. If it is, than perhaps it's a non-risk.
Finally, risk is not risk if it is anticipated. In most currencies there are futures or forward
exchange contracts whose prices give firms an indication of where the market expects currencies
to go. And these contracts offer the ability to lock in the anticipated change. So perhaps a better
concept of exchange risk is unanticipated exchange rate changes.
These and other issues justify a closer look at this area of international financial management.
A trade restriction is an artificial restriction on the trade of goods and/or services between two
countries. It is the byproduct of protectionism.

Consequences of Trade Restrictions
A combination of tariffs, quotas, and subsidies can serve economic, and sometimes political,
objectives, but they can also impose significant costs. Tariffs or quantitative restrictions protect
domestic industries and workers from foreign competition by raising the prices of imported
goods. In this respect, some argue that import restrictions should be viewed as a tax on domestic
consumers. According to some experts, the costs of protecting the jobs of workers in vulnerable
industries, which are ultimately borne by taxpayers or consumers, far exceed the potential cost of
retraining and finding new jobs for those workers.
According to the Institute for International Economics, trade barriers cost American consumers
$80 billion a year, or more than $1,200 per family, in increased prices for goods such as sugar
(and foods made with it) and appliances made from steel. The Organization for Economic Co-
operation and Development estimated that in 2004, American consumers paid $1.5 billion
because of U.S. sugar policies (Smith, 2006).
A similar analysis can be applied to export subsidies. Subsidizing exports can cost governments
much more money than would programs designed to shift uncompetitive production into more
efficient or internationally competitive sectors. An example of this can be seen in the American
Automobile Industry.
Another criticism of import restrictions and export subsidies is that they discourage the protected
firms and industries from making the changes necessary to challenge foreign competition. Once
the protected companies have received government support in the form of import restrictions or
export subsidies, they may have less incentive to improve their efficiency and management,
eventually even becoming dependent on government support for their survival.
Finally, trade restrictions are a major impediment to development efforts. Developing countries
are unable to sell their products abroad because of high tariffs and quotas. Additionally, their
domestic markets are flooded by cheaper, subsidized products from abroad.
In response to the known problems associated with trade restrictions, the World Bank offers
three suggestions that the G20 countries could adopt. These leading countries could:
1. ―Commit to greater transparency by agreeing to provide quarterly reports on new trade
restrictions, and industrial and agricultural subsidies to the WTO;
2. Advocate greater Aid for Trade for low income countries; and
3. Seize the opportunity to support global trade in a time when it desperately needs to be
supported (World Bank, 2009)
Pros and Cons of Trade Restrictions?
Answer
Trade restrictions are barriers put in place by countries in order to protect their domestic industries.
These are advantageous since they allow new industries to develop in a less competing environment
and protect domestic jobs and workers. However, it is also disadvantageous since it leads to higher
prices of goods and services, gives consumers less choices and leads to loss of jobs in international
companies.
A developing country, also called a less-developed country (LDC),
[1]
is a nation with a low living
standard, underdeveloped industrial base, and low Human Development Index (HDI) relative to other
countries.
[2][3]
There is no universal, agreed-upon criteria for what makes a country developing versus
developed and which countries fit these two categories, although there are general reference points
such as the size of a nation's GDP compared to other nations.
A developed country or "more developed country" (MDC), is a sovereign state that has a highly
developed economy and advanced technological infrastructure relative to other less developed nations.
With the aim of stimulating economic growth, governments and enterprises of developing
countries, in the face of tight financial and monetary constraints, resort to various fundraising
measures, including the issuing of local/foreign currency-denominated bonds, aids (loans) from
development organizations and developed countries, and borrowings from private financial
institutions. Since the 1980s in particular, the global trend toward financial liberalization has led
to a diversified financing measures for developing countries. However, the redemption and/or
principal and interest repayments have not always taken place on schedule. As a result of
endogenous problems such as the vulnerable tax base, or exogenous shocks such as falling prices
for foreign-currency earning products, natural disasters and currency and financial crisis , which
the governments cannot control by themselves, countries often face solvency problems and go
into default (This situation is also called a "debt crisis").
more
For creditors, default means a low recovery rate and a deterioration of business performance,
while for debtors, it invites many problems that cannot be overlooked, ranging from difficulties
in financing the immediate repayment to rising funding costs for future development (in the
worst case, financing may become totally infeasible). In the latter half of the 1970s, when the
problem of debt accumulation surfaced, the cause was deemed as a temporary liquidity shortage
on the part of the debtors, meaning the developing countries. Then, in the latter half of the 1980s,
the debt accumulation came to be recognized as a structural problem stemming from an
insufficient economic performance for making repayments, and the international community
started discussions to address this problem. Given these circumstances, with the support of the
IMF and World Bank, the Baker Plan (1985) and the Brady Plan (1987) were compiled. The
Baker Plan consists of the following solutions: (1) rearranging the principal and interest
repayments to a sustainable schedule (rescheduling) or (2) forgiving part of the principal and
interest repayment (haircut), obligating the creditor group to act in a uniform manner. The Brady
Plan, in addition to (1) and (2) which may require a lengthy process for creditors to reach an
agreement, offered the idea to (3) securitize the debts and sell them to investors willing to take
high risks (securitization). These plans have been applied to Latin American and South East
Asian countries. Most of the countries affected by the Asian currency and financial crisis in 1997
used the securitization scheme (e.g., Asset Backed Securities) to write off the bad debts of public
and private enterprises.

The debt problem also has internal impacts in addition to the external problem of repayment. The
purpose of development finance per se should be to improve the economic strength and people' s
welfare and reduce poverty (related themes: economic growth, poverty, inequality), but in
reality, heavily indebted poor countries (HIPCs, e.g., most African countries) have not
established a good track record of making improvements in either debt or poverty reduction. Past
studies have shown that in a debt crisis, the poorest people living in precarious conditions are
hardest hit. Given this situation, the IMF and World Bank launched the HIPC Initiative in 1996.
The scheme, which was designed to reduce the debts of HIPCs that met certain criteria to a
sustainable level, was implemented in collaboration with the governments and private creditor
organizations. By June 2009, debt reductions under the scheme including interim debt relief were
approved for 35 countries. Further, in order to expedite debt relief for HIPCs by international
organizations, an idea that was incorporated as one of the Millennium Development Goals
(MDGs), the Multilateral Debt Relief Initiative (MDRI) with a similar scheme was launched in
2005 through the G8 agreement in Gleneagles. A total of 26 countries including non-HIPCs were
given debt relief from the IMF, IDA and African Development Fund (as of June 2009), and 16
more are scheduled to receive debt relief. In the aftermath of the worldwide recession in 2007,
similar relief measures have been considered among the Inter-American Development Bank and
other international organizations.

Now, what are needed to prevent debt crisis and/or reduce the heavy debt burden? From the
viewpoint of development economics, the above-described countermeasures on the expenditure
(spending) side, e.g., reducing debts per se, as well as improving revenues (income), i.e.,
stabilizing the monetary (fiscal) base and controlling outstanding obligations, are important
subjects of analyses. From the latter half of the 1990s in particular, ―debt and poverty reduction
that can promote economic development,‖ which was incorporated as one of the MDGs, and the
―contingent liability‖ issues that derive from the privatization of public enterprises (or its
failure), which was promoted in the 1980s and subsequent years as part of the structural
adjustment, have been capturing attentions. Efforts are also being made to develop indicators to
quantify various debt-related risks that governments have to control, in order to enable them to
prevent debt accumulation from exceeding a sustainable level.

A single market is a type of trade bloc which is composed of a free trade area (for goods) with
common policies on product regulation, and freedom of movement of the factors of production
(capital and labour) and of enterprise and services. The goal is that the movement of capital,
labour, goods, and services between the members is as easy as within them.
[1]
The physical
(borders), technical (standards) and fiscal (taxes) barriers among the member states are removed
to the maximum extent possible. These barriers obstruct the freedom of movement of the four
factors of production.
A common market is a first stage towards a single market, and may be limited initially to a free
trade area with relatively free movement of capital and of services, but not so advanced in
reduction of the rest of the trade barriers.
The European Economic Community was the first example of a both common and single market,
but it was an economic union since it had additionally a customs union.
Contents
 1 Benefits and costs
 2 List of single markets
o 2.1 Proposed
 3 References
 4 External links
Benefits and costs
A single market has many benefits. With full freedom of movement for all the factors of
production between the member countries, the factors of production become more efficiently
allocated, further increasing productivity.
For both business within the market and consumers, a single market is a very competitive
environment, making the existence of monopolies more difficult. This means that inefficient
companies will suffer a loss of market share and may have to close down. However, efficient
firms can benefit from economies of scale, increased competitiveness and lower costs, as well as
expect profitability to be a result. Consumers are benefited by the single market in the sense that
the competitive environment brings them cheaper products, more efficient providers of products
and also increased choice of products. What is more, businesses in competition will innovate to
create new products; another benefit for consumers.
Transition to a single market can have short term negative impact on some sectors of a national
economy due to increased international competition. Enterprises that previously enjoyed national
market protection and national subsidy (and could therefore continue in business despite falling
short of international performance benchmarks) may struggle to survive against their more
efficient peers, even for its traditional markets. Ultimately, if the enterprise fails to improve its
organization and methods, it will fail. The consequence may be unemployment or
migration.
[citation needed]

Examples:
Canada – Agreement on Internal Trade (AIT)- The Agreement on Internal Trade is an
intergovernmental agreement between the federal government and the provinces and territories to
reduce and eliminate barriers to free movement of people, goods, services and investments within
Canada. Under the Agreement, these governments have agreed to apply the principles of non-
discrimination, transparency, openness and accessibility with respect to their procurement
opportunities and those of their municipalities and municipal organizations, school boards and publicly
funded academic, health and social services entities. The Agreement covers only those tenders where
the procurement value exceeds a specified amount.

South Asian Free Trade Area (SAFTA)- The South Asian Free Trade Area or SAFTA is an
agreement reached on 6 January 2004 at the 12th SAARC summit in Islamabad, Pakistan. It
created a free trade area of 1.6 billion people in Bangladesh, Bhutan, India, Maldives, Nepal,
Pakistan and Sri Lanka (as of 2011, the combined population is 1.8 billion people). The seven
foreign ministers of the region signed a framework agreement on SAFTA to reduce customs
duties of all traded goods to zero by the year 2016.
The SAFTA agreement came into force on 1 January 2006 and is operational following the
ratification of the agreement by the seven governments. SAFTA requires the developing
countries in South Asia (India, Pakistan and Sri Lanka) to bring their duties down to 20 percent
in the first phase of the two-year period ending in 2007. In the final five-year phase ending 2012,
the 20 percent duty will be reduced to zero in a series of annual cuts. The least developed nations
in South Asia (Nepal, Bhutan, Bangladesh, Afghanistan and Maldives) have an additional three
years to reduce tariffs to zero. India and Pakistan ratified the treaty in 2009, whereas Afghanistan
as the 8th memberstate of the SAARC ratified the SAFTA protocol on the 4th of May 2011.
[1]


European Free Trade Association (EFTA)- The European Free Trade Association (EFTA) is a
free trade organisation between four European countries that operates in parallel with – and is
linked to – the European Union (EU). The EFTA was established on 3 May 1960 as a trade bloc-
alternative for European states who were either unable or unwilling to join the then-European
Economic Community (EEC) which has now become the EU. The Stockholm Convention,
establishing the EFTA, was signed on 4 January 1960 in the Swedish capital by seven countries
(known as the "outer seven").
Today's EFTA members are Liechtenstein, Iceland, Norway and Switzerland, of which the latter
two were founding members. The initial Stockholm Convention was superseded by the Vaduz
Convention, which enabled greater liberalisation of trade among the member states.
EFTA states have jointly concluded free trade agreements with a number of other countries.
Three of the EFTA countries are part of the European Union Internal Market through the
Agreement on a European Economic Area (EEA), which took effect in 1994; the fourth,
Switzerland, opted to conclude bilateral agreements with the EU. In 1999, Switzerland
concluded a set of bilateral agreements with the European Union covering a wide range of areas,
including movement of people, transport, and technical barriers to trade. This development
prompted the EFTA states to modernise their Convention to ensure that it will continue to
provide a successful framework for the expansion and liberalization of trade among themselves
and with the rest of the world.

 European Economic Area (EEA)
 Switzerland – European Union
[2]

 Common Economic Space of the Customs Union of Belarus, Kazakhstan and Russia
[3]


A single market agreement essentially creates a single economic life across national borders. It
makes national borders, economically speaking, irrelevant. A single market is distinct from a free
trade area, which only seeks to lower tariffs and streamline some trading regulations. In general,
a single market agreement differs from a free trade area in its level of comprehensiveness, taking
into itself nearly all aspects of economic life above and beyond tariff policy.

Read more: http://www.ehow.com/info_7752584_single-market-agreement.html#ixzz2elLdszJO
Regional trade agreements (RTAs) cover more than half of international trade and operate
alongside global multilateral agreements under the World Trade Organization (WTO). The first
eleven years (1995-2005) of the WTO were paralleled by a tripling of RTAs officially notified to
the WTO and in force, from 58 to 188*.

However, regional trade agreements can have both positive and negative effects.
They can be attractive, for example, because it may be easier for a small group of neighbouring
countries with similar concerns and cultures to agree on market opening in a particular area than
to reach agreement in a wider forum such as the WTO. They can also offer new approaches to
rule-making and so act as stepping stones on the way to a multilateral agreement.

But regional agreements also risk making it harder for countries outside the region to trade with
those inside and may discourage further opening up of markets, ultimately limiting growth
prospects for all. Moreover, broad-based multilateral negotiations, with more players and more
sectors, will offer greater potential for mutual gain than limited bilateral or regional deals.
The World Trade Organization (WTO) is an organization that intends to supervise and
liberalize international trade. The organization deals with regulation of trade between
participating countries; it provides a framework for negotiating and formalizing trade
agreements, and a dispute resolution process aimed at enforcing participants' adherence to WTO
agreements, which are signed by representatives of member governments
[6]:fol.9–10
and ratified by
their parliaments.
[7]
Most of the issues that the WTO focuses on derive from previous trade
negotiations, especially from the Uruguay Round (1986–1994).
The organization is attempting to complete negotiations on the Doha Development Round, which
was launched in 2001 with an explicit focus on addressing the needs of developing countries. As
of June 2012, the future of the Doha Round remains uncertain: the work programme lists 21
subjects in which the original deadline of 1 January 2005 was missed, and the round is still
incomplete.
[8]
The conflict between free trade on industrial goods and services but retention of
protectionism on farm subsidies to domestic agricultural sector (requested by developed
countries) and the substantiation of the international liberalization of fair trade on agricultural
products (requested by developing countries) remain the major obstacles. These points of
contention have hindered any progress to launch new WTO negotiations beyond the Doha
Development Round. As a result of this impasse, there has been an increasing number of
bilateral free trade agreements signed.
[9]
As of July 2012, there are various negotiation groups in
the WTO system for the current agricultural trade negotiation which is in the condition of
stalemate.
[10]

WTO's current Director-General is Roberto Azevêdo,
[11][12]
who leads a staff of over 600 people
in Geneva, Switzerland.
[13]

An international organization is an organization with an international membership, scope, or
presence. There are two main types:
[2]

 International nongovernmental organizations (INGOs): non-governmental organizations
(NGOs) that operate internationally. There are two types:
o International non-profit organizations. Examples include the World Organization
of the Scout Movement, International Committee of the Red Cross and Médecins
Sans Frontières.
o International corporations, referred to as multinational corporations. Examples
include The Coca-Cola Company and Toyota.
 Intergovernmental organizations, also known as international governmental organizations
(IGOs): the type of organization most closely associated with the term 'international
organization', these are organizations that are made up primarily of sovereign states
(referred to as member states). Notable examples include the United Nations (UN),
Organisation for Economic Co-operation and Development (OECD) Organization for
Security and Co-operation in Europe (OSCE), Council of Europe (CoE), European Union
(EU; which is a prime example of a supranational organization), and World Trade
Organization (WTO). The UN has used the term "intergovernmental organization"
instead of "international organization" for clarity.
[3]

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 6 Factors That Influence Exchange Rates
 July 23 2010| Filed Under » Exchange Rate Regime, Forex Fundamentals, Inflation,
Macroeconomics
 Aside from factors such as interest rates and inflation, the exchange rate is one of the
most important determinants of a country's relative level of economic health. Exchange
rates play a vital role in a country's level of trade, which is critical to most every free
market economy in the world. For this reason, exchange rates are among the most
watched, analyzed and governmentally manipulated economic measures. But exchange
rates matter on a smaller scale as well: they impact the real return of an investor's
portfolio. Here we look at some of the major forces behind exchange rate movements.

Overview
Before we look at these forces, we should sketch out how exchange rate movements
affect a nation's trading relationships with other nations. A higher currency makes a
country's exports more expensive and imports cheaper in foreign markets; a lower
currency makes a country's exports cheaper and its imports more expensive in foreign
markets. A higher exchange rate can be expected to lower the country's balance of trade,
while a lower exchange rate would increase it.

Determinants of Exchange Rates
Numerous factors determine exchange rates, and all are related to the trading relationship
between two countries. Remember, exchange rates are relative, and are expressed as a
comparison of the currencies of two countries. The following are some of the principal
determinants of the exchange rate between two countries. Note that these factors are in no
particular order; like many aspects of economics, the relative importance of these factors
is subject to much debate.
 Try Currency Trading Risk-Free at FOREX.com

 1. Differentials in Inflation
As a general rule, a country with a consistently lower inflation rate exhibits a rising
currency value, as its purchasing power increases relative to other currencies. During the
last half of the twentieth century, the countries with low inflation included Japan,
Germany and Switzerland, while the U.S. and Canada achieved low inflation only later.
Those countries with higher inflation typically see depreciation in their currency in
relation to the currencies of their trading partners. This is also usually accompanied by
higher interest rates. (To learn more, see Cost-Push Inflation Versus Demand-Pull
Inflation.)

2. Differentials in Interest Rates
Interest rates, inflation and exchange rates are all highly correlated. By manipulating
interest rates, central banks exert influence over both inflation and exchange rates, and
changing interest rates impact inflation and currency values. Higher interest rates offer
lenders in an economy a higher return relative to other countries. Therefore, higher
interest rates attract foreign capital and cause the exchange rate to rise. The impact of
higher interest rates is mitigated, however, if inflation in the country is much higher than
in others, or if additional factors serve to drive the currency down. The opposite
relationship exists for decreasing interest rates - that is, lower interest rates tend to
decrease exchange rates. (For further reading, see What Is Fiscal Policy?)

3. Current-Account Deficits
The current account is the balance of trade between a country and its trading partners,
reflecting all payments between countries for goods, services, interest and dividends. A
deficit in the current account shows the country is spending more on foreign trade than it
is earning, and that it is borrowing capital from foreign sources to make up the deficit. In
other words, the country requires more foreign currency than it receives through sales of
exports, and it supplies more of its own currency than foreigners demand for its products.
The excess demand for foreign currency lowers the country's exchange rate until
domestic goods and services are cheap enough for foreigners, and foreign assets are too
expensive to generate sales for domestic interests. (For more, see Understanding The
Current Account In The Balance Of Payments.)

4. Public Debt
Countries will engage in large-scale deficit financing to pay for public sector projects and
governmental funding. While such activity stimulates the domestic economy, nations
with large public deficits and debts are less attractive to foreign investors. The reason? A
large debt encourages inflation, and if inflation is high, the debt will be serviced and
ultimately paid off with cheaper real dollars in the future.

In the worst case scenario, a government may print money to pay part of a large debt, but
increasing the money supply inevitably causes inflation. Moreover, if a government is not
able to service its deficit through domestic means (selling domestic bonds, increasing the
money supply), then it must increase the supply of securities for sale to foreigners,
thereby lowering their prices. Finally, a large debt may prove worrisome to foreigners if
they believe the country risks defaulting on its obligations. Foreigners will be less willing
to own securities denominated in that currency if the risk of default is great. For this
reason, the country's debt rating (as determined by Moody's or Standard & Poor's, for
example) is a crucial determinant of its exchange rate.

5. Terms of Trade
A ratio comparing export prices to import prices, the terms of trade is related to current
accounts and the balance of payments. If the price of a country's exports rises by a greater
rate than that of its imports, its terms of trade have favorably improved. Increasing terms
of trade shows greater demand for the country's exports. This, in turn, results in rising
revenues from exports, which provides increased demand for the country's currency (and
an increase in the currency's value). If the price of exports rises by a smaller rate than that
of its imports, the currency's value will decrease in relation to its trading partners.

6. Political Stability and Economic Performance
Foreign investors inevitably seek out stable countries with strong economic performance
in which to invest their capital. A country with such positive attributes will draw
investment funds away from other countries perceived to have more political and
economic risk. Political turmoil, for example, can cause a loss of confidence in a
currency and a movement of capital to the currencies of more stable countries.

Conclusion
The exchange rate of the currency in which a portfolio holds the bulk of its investments
determines that portfolio's real return. A declining exchange rate obviously decreases the
purchasing power of income and capital gains derived from any returns. Moreover, the
exchange rate influences other income factors such as interest rates, inflation and even
capital gains from domestic securities. While exchange rates are determined by numerous
complex factors that often leave even the most experienced economists flummoxed,
investors should still have some understanding of how currency values and exchange
rates play an important role in the rate of return on their investments.
In finance, an exchange rate (also known as a foreign-exchange rate, forex rate, FX rate or Agio)
between two currencies is the rate at which one currency will be exchanged for another. It is also
regarded as the value of one country’s currency in terms of another currency.
Exchange rate regime
Main article: Exchange rate regime
Each country, through varying mechanisms, manages the value of its currency. As part of this
function, it determines the exchange rate regime that will apply to its currency. For example, the
currency may be free-floating, pegged or fixed, or a hybrid.
If a currency is free-floating, its exchange rate is allowed to vary against that of other currencies
and is determined by the market forces of supply and demand. Exchange rates for such
currencies are likely to change almost constantly as quoted on financial markets, mainly by
banks, around the world.
A movable or adjustable peg system is a system of fixed exchange rates, but with a provision for
the revaluation (usually devaluation) of a currency. For example, between 1994 and 2005, the
Chinese yuan renminbi (RMB) was pegged to the United States dollar at RMB 8.2768 to $1.
China was not the only country to do this; from the end of World War II until 1967, Western
European countries all maintained fixed exchange rates with the US dollar based on the Bretton
Woods system. [1] But that system had to be abandoned in favor of floating, market-based
regimes due to market pressures and speculations in the 1970s.
Still, some governments strive to keep their currency within a narrow range. As a result,
currencies become over-valued or under-valued, leading to excessive trade deficits or surpluses.
Fluctuations in exchange rates
A market-based exchange rate will change whenever the values of either of the two component
currencies change. A currency will tend to become more valuable whenever demand for it is
greater than the available supply. It will become less valuable whenever demand is less than
available supply (this does not mean people no longer want money, it just means they prefer
holding their wealth in some other form, possibly another currency).
Increased demand for a currency can be due to either an increased transaction demand for money
or an increased speculative demand for money. The transaction demand is highly correlated to a
country's level of business activity, gross domestic product (GDP), and employment levels. The
more people that are unemployed, the less the public as a whole will spend on goods and
services. Central banks typically have little difficulty adjusting the available money supply to
accommodate changes in the demand for money due to business transactions.
Speculative demand is much harder for central banks to accommodate, which they influence by
adjusting interest rates. A speculator may buy a currency if the return (that is the interest rate) is
high enough. In general, the higher a country's interest rates, the greater will be the demand for
that currency. It has been argued
[by whom?]
that such speculation can undermine real economic
growth, in particular since large currency speculators may deliberately create downward pressure
on a currency by shorting in order to force that central bank to buy their own currency to keep it
stable. (When that happens, the speculator can buy the currency back after it depreciates, close
out their position, and thereby take a profit.)
[citation needed]

For carrier companies shipping goods from one nation to another, exchange rates can often
impact them severely. Therefore, most carriers have a CAF charge to account for these
fluctuations.
[6][7]

Purchasing power of currency
The real exchange rate (RER) is the purchasing power of a currency relative to another at
current exchange rates and prices. It is the ratio of the number of units of a given country's
currency necessary to buy a market basket of goods in the other country, after acquiring the other
country's currency in the foreign exchange market, to the number of units of the given country's
currency that would be necessary to buy that market basket directly in the given country .
Thus the real exchange rate is the exchange rate times the relative prices of a market basket of
goods in the two countries. For example, the purchasing power of the US dollar relative to that of
the euro is the dollar price of a euro (dollars per euro) times the euro price of one unit of the
market basket (euros/goods unit) divided by the dollar price of the market basket (dollars per
goods unit), and hence is dimensionless. This is the exchange rate (expressed as dollars per euro)
times the relative price of the two currencies in terms of their ability to purchase units of the
market basket (euros per goods unit divided by dollars per goods unit). If all goods were freely
tradable, and foreign and domestic residents purchased identical baskets of goods, purchasing
power parity (PPP) would hold for the exchange rate and GDP deflators (price levels) of the two
countries, and the real exchange rate would always equal 1.
The rate of change of this real exchange rate over time equals the rate of appreciation of the euro
(the positive or negative percentage rate of change of the dollars-per-euro exchange rate) plus the
inflation rate of the euro minus the inflation rate of the dollar.