Why is Trade Important and How Does it Work?
Why is trade important and how does it work? The answer is as varied as the people who practice it. For instance, shoemakers might lobby for special tax breaks or extra duties on foreign footwear to protect American jobs and time-honored crafts. But such protectionist tactics would likely only harm American consumers and workers, and would only encourage more inefficient trade. A more positive view is that free trade promotes efficiency by allowing countries to participate in the global economy and attract foreign direct investment.
When a country opens up its markets to foreign trade, the demand for goods changes and local markets respond to this change. Lower prices benefit consumers and wage earners, but these changes can’t compensate for the lost jobs of workers in the trade sector. As such, trade is a positive force for the overall welfare of nations. However, the negative side of international trade is that it often places smaller countries at a disadvantage in global affairs.
The benefits of international trade are numerous. In terms of economics, trade is one of the most significant drivers of economic growth. It supports good jobs at home, raises living standards, and helps Americans provide for their families. Traded goods aren’t only tangible products, but also services. Many of the traded services make merchandise trade easier and cheaper. Examples include shipping services and financial services. When countries engage in international trade, they reduce their costs and create opportunities for innovation.
Despite the positive effects of trade on employment and inequality, it is also a major cause for concern. Many argue that trade does not increase incomes equally among the poor and middle-class. However, the impact on firm productivity has been studied thoroughly. By using geography as a proxy for trade, Frankel and Romer conclude that trade does increase employment in poor countries. They also note that there are no other factors that explain the negative impact on employment and incomes of poor countries.
In the empirical literature, geography has been widely studied in relation to trade. In a graph like the one above, import shares are plotted against distance, with each dot representing a country-pair. The vertical axis shows average imports and exports, while the horizontal axis measures distance. As a result, trade between countries and their neighboring countries is increasing. It’s also important to note that services are becoming more important to economic development.
During the past two decades, China has been a major driver of global trade. According to the UN Human Development Report, China’s trade with Sub-Saharan Africa rose from $1 billion to more than $140 billion. Increasing levels of international trade have led to the creation of more preferential trade agreements. These agreements reduce tariffs between participating countries. For example, China has increased its trade with sub-Saharan Africa from $1 billion in 1992 to over $14 billion in 2011.