INTERNATIONAL ECONOMICS: International trade

This chapter requires that you read between the lines to get a logical understanding of the subject matter. It is not difficulty to
understand but will require your attention so that you understand it well.

Introduction

Meaning of trade

Trade is the exchange of goods and services for money or for other goods and services. Trade is also defined
as the exercise of buying and selling of goods with a view of making profit. People involved in trade, called
traders, exchange goods and services for money or for other goods or services. When goods are exchanged
for other goods or services, barter trade is said to occur. Because of the limitations of barter trade, money is
used as a medium of exchange. Trade is one of the main economic activities of our nation.

Classification of trade

Trade can be classified as either Home trade or international trade. Home trade is trade that occurs within
the borders of a country. People exchange goods and services for money or for other goods within the
country. When people of a country exchange goods and services with people of other countries, international
trade is said to occur. It involves either buying goods from other countries or selling goods to other
countries. Imports are goods we buy from other countries while exports are goods we sell to other countries.
Besides goods we also offer or receive services in exchange for money. E.g. Kenyans go to India for advanced
health care. Health care becomes export of a service by India while we regard the purchase of the service as a
Kenyan import. Examples of Kenyan exports of services include gains from tourism, hospitality, money from
our national airline (Kenya Airways), Banking etc.

Classification of trade

Trade

Home trade International

trade

Wholesale Retail Import Export

*Home trade -trade that takes place within the borders of a country. Also called domestic/internal/local trade

* Wholesale Trade- Buying goods in large quantities for resale to other traders, usually retailers.

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* Retail Trade- Buying goods to sale to final consumers

*International trade- Trade between people of a country and other countries. It’s also called foreign trade or
external trade. It can be bilateral trade or multilateral. Bilateral trade is an agreement between two countries,
to promote trade and commerce between them which is mutually beneficial for economic development and
stability. It opens markets and eliminates or reduces tariff and non-tariff barriers to trade. A Bilateral Trade
Agreement (BTA) gives preferential treatment to products from a certain country enabling trade and
investment between the two countries. They eliminate trade barriers such as tariffs, import quotas, and
export restraints in order to encourage trade and investment. The main advantage of bilateral trade
agreements is an expansion of the market for a country's goods through concerted negotiation between two
countries. A multilateral agreement(MTA), on the other hand, is a trade agreement established between
three or more countries with the intention of reducing barriers to trade, such as tariffs, subsidies, and
embargoes, that limit a nation’s ability to import or export goods. They are considered the best method of
encouraging a truly global economy that opens markets to small and large countries on an equitable basis.

Importance of international trade /advantages of international trade

The ability of a country or firms and people of a country to do business with others beyond the borders of
the country comes with the following benefits:

 Wide market of goods which encourages companies to do mass production. Mass production enables
them to enjoy economies of scale
 Economies of scale lead to reduced unit costs of production. This benefit is transferred to consumers by
way of low prices.
 Mass undertakings create massive job opportunities. Employment enables people to have better living
standards
 International trade is one of the main economic activities of people of different nations. It’s a major
contributor to a nation’s Gross National product(GNP)
 It enable countries to earn foreign exchange which it can use to pay for her imports
 It promotes efficiency in production-uneven distribution of economic resources mean different countries
are blessed differently in terms of what they can produce comfortably at large scale and at the least cost.
Each Country can specialize on production on what she can produce at the least cost. The end result
being products exchanged are produced at least costs from different places in the globe. This concept is
called comparative advantage.
 It brings about competition between the imported and locally produced goods, leading to improvement
in their quality
 Wide markets enable a country to fully exploit her natural resources; surplus production becomes the
least bother.
 It enable the country to get access to wider range/variety of goods and services from other countries
 It enable the country to get what it does not produce
 It promotes global peace and co-existence
 It enable the country to specialize in its production activities where they feel they have an advantage
 It earns the country revenue through taxes and licenses fees paid by the importers and exporters in the
country.
 It creates employment opportunities to the citizens of that country either directly or indirectly
 It may lead to the development of the country through importation of capital goods in to the country
 It enable countries to earn foreign exchange which it can use to pay for its imports
 A country may be able to obtain goods and services cheaply than if they have been produced locally
 It brings about competition between the imported and locally produced goods, leading to improvement
in their quality

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Disadvantages of International Trade

 It may lead to collapse of the local industries-imported goods may pose a lot of competition in the
domestic market.
 The collapse of local business/industries may leads to employment
 It may also lead to importation of harmful foods and services such as drugs and pornographic
materials
 May lead to over dependence on imported commodities especially the essential ones, making the
country to be a slave of the other countries, interfering with her sovereignty
 A country used to imported goods may suffer during emergencies or wars because of lack of internal
supply
 May make the country to suffer from import inflation
 May lead to acquisition of bad culture from other countries as a result of global interactions with
people of different upbringings.
 May lead to unfavorable balance of payment, net inflows into the country are more than outflows of
money

Terms of Trade (TOT)

Terms of trade (TOT) refers to the rate at which a country’s exports exchanges for her imports. It’s the ratio
of a country’s export prices to her import prices. It can be interpreted as the amount of import goods an
economy can purchase per unit of export goods.

Terms of trade (TOT) is thus a measure of how much imports an economy can get for a unit of
exported goods. For example, if an economy is only exporting apples and only importing oranges,
then the terms of trade are simply the price of apples divided by the price of oranges — in other
words, how many oranges can be obtained for a unit of apples. Since economies export and import
many goods, measuring the TOT requires defining price indices for exported and imported goods
and comparing the two.

If a country such as Costa Rica primarily exports Magnesium and imports Titanium, then the terms
of trade is simply the price of Magnesium divided by the price of Titanium and then multiplied by
100. For instance, if the price of Magnesium is USD 9 for a kilo and the price of Titanium is USD 17
for a kilo, then the terms of trade is basically (9/17) * 100 = 52.9. Thus, the terms of trade for Costa
Rica would be 52.9, which is very low and indicates that the country does not possess a high
purchase power when it comes to imports. Terms of trade is thus the amount of imported products
an economy can purchase per unit of exported products

A rise in the prices of exported goods in comparison to prices of her imported goods would increase
the TOT, while a rise in the prices of imported goods relative to price of exports would decrease it.
For example, countries that export oil will see an increase in their TOT when oil prices go up, while
the TOT of countries that import oil would see a decrease i.e. the country may buy more from sale
of a liter of oil if the price of one unit of her imports remain the same or falls.

Reasons for Differences in Terms of Trade between Countries

Some countries may have favorable terms of trade while others suffer unfavorable terms- in fact as
much as one trading partner is enjoying favorable terms of trade, the other one would be facing
unfavorable terms
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The terms of trade may differ due to:

i. The nature of the commodity being exported. If a country exports raw materials, or
unprocessed agricultural products, its terms of trade will be unfavorable, as compared to a
country that exports manufactured goods
ii. Nature of the commodity being imported. A country that imports manufactured goods is
likely to have unfavorable terms of trade as compared to that which imports raw materials or
agricultural produce
iii. Change in demand for a country’s export. An increase in demand for the country’s export at
the world market will make it have favorable terms of trade as compared to those with low
demand at the world market
iv. Existing of world economic order favoring the products from more developed countries.
Developed countries happen to collectively dictate the prices at which to buy their imports
or whether to buy the imports as raw materials or as finished goods from developing
countries. This may make the developing countries to have deteriorating terms of trade
v. Total quantity supplied of a product in the world markets. A country exporting what most
other countries are exporting will have their products trading at a low price and shall thus
experience unfavorable terms of trade as compared to a country that exports what only few
countries can export.

Balance of trade

The balance of trade (BOT) of a country is defined as the difference between the value of exports and the
value of imports of the country. The figure that is derived the gains a country makes from international
trade. Visible trade refers trade in goods only while invisible trade refers to trade in services only.

Merchandise trade balance is the difference between exports of goods minus imports of goods. It is the most
‚politically correct term‛. But the better concept of ‚the trade balance‛ is the trade balance in merchandise and
services. This is exports of both goods and services minus imports of both goods and services.

Thus, the trade balance (TB) = X –IM (where X are the exports value and IM are the imports value for both
goods and services of a nation).

Example:

The United States imported $239 billion in goods and services in August 2020 but exported only $171.9
billion in goods and services to other countries. So, in August, the United States had a trade balance of (-
$67.1 billion) or a $67.1 billion trade deficit.

Balance of payments (BOPs)

The balance of payments, also known as the balance of international payments, abbreviated BOPs, is a record
of all economic transactions between a country and the rest of the world over a particular period, usually one
year. Cross border transactions are made by individuals, governments and firms by way of trade in goods
and services, payments for factor services, foreign direct investments; unilateral transfers etc. A balance of
payments is a document prepared to compare the inflows of income of a country from the rest of the world
with outflows to the rest of the world within a particular period of time (e.g. within a quarter or a whole
year).

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 BOPs Accounts

Information about flow of money and assets between a country and the rest of the word is ordered in two
main accounts and a mini account known as the official settlement account:

• The current account &

• The Capital Account (also called the financial account)

1. The current account of the balance of payments

In the current account (CA) of the BOPs of a nation, the following is specifically recorded:

a) Income received into a nation out of exports of goods and services to other nations(+)
b) Payments of money out of a country out of imports of goods and services to other nation(-)
The difference between (a) and (b) above is the countries balance of trade. Thus balance of trade is a
significant part of balance of payments. i.e imports and exports are key determinants of whether we
gain or loss from the rest of the world.
c) Investments Income- corporate/ company profits-businesses and dividends-earnings by shareholders
of such companies owned by a country’s citizens operating outside the country(+)
 Outflow of investment income by foreign investors within a country(-)
 Net Factor income from abroad- net difference between factor payments abroad and payments
within the country.
 Net unilateral transfers.
Factors that lead to a flow of money into the country (i.e. a +) are recorded into the credit side (credited) of
the current account while those that lead to payments (outflow of money (-) )of revenue are recorded on the
debit side (debited)

E.g. Exports yield income into the country exporting and are recorded by crediting the money value of the
exports in the current account. Imports lead to outflow of money from a country and are debited.

Net Factor income from abroad(NFI) or net factor payments (NFP) refer to receipts of income by home
residents working abroad or owning capital and land abroad, minus income paid out to foreigners working
here or owning capital and land within the country. E.g. salaries and wages earned by citizens outside the
country visa-vis those paid to foreigners within the country.

Net unilateral transfers refer to payments of money or receipts of money without any service or good or
service expected in return. E.g. remittances of cash by a country’s citizens in a foreign land to their relatives
back home, gifts between citizens of different countries of the world, grants and non-conditional foreign aid.
The net difference between what comes in and what goes out in respect to this kind of transactions is called
the Net Unilateral Transfers (NUT). The current account balance (CAB) is thus the sum of these categories:

CAB = (X –IM) + NFI + NUT.

2. The capital account of the BOPs

This account deals with flow of capital and financial assets between a country and the rest of the world. It
does not deal in importation and exportation of physical items. In it is included the flow of short term and

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long term capital between a country and the rest of the world. Capital refers to financial capital or
real/physical capital. Financial capital refers to money as used by businesses to acquire or buy what they
need in order to produce or offer their services. Real capital on the other hand comprises physical goods that
assist in the production of other goods and services i.e. producer goods

Capital flow into a country may arise from:

• Sale of foreign assets e.g. a country’s building in a foreign land etc.

• Commercial borrowings- loans to a country’s citizens or the government from external banks or
other nations. However interest payable for the loans counts as income from abroad to the lending
nation and it’s a plus in her current account but a minus in the current account of the borrowing
nation

• Flows due to Foreign Direct Investments (FDIs) - this refers to flows of capital due to long term
capital investment by foreigners into a nation by way of purchase or construction of machinery,
buildings, or manufacturing plants. It’s regarded as a FDI when the investor has more than 10%
ownership in the ownership of ordinary shares and which grants him voting/ controlling powers. If
foreigners are investing in a country, that represents an inward flow of capital into a country and
would be recorded as a credit in the capital account of the country. On the other hand if a nation’s
citizens are investing in foreign countries that counts as an outward flow of capital and would be
recorded on the debit side of the country’s capital account. NB: after the initial investment, any yearly
profits that are not reinvested will flow in the opposite direction but will be recorded in the country’s
current account.ie income from investment but owned by a foreign nation and which counts as a plus
from abroad by the investor’s nation but an outflow of income by the host nation.

• Portfolio investments-this refers to the purchase of shares and bonds as sold by country’s companies
or purchase of treasury bills and bonds (government securities) by foreigners. Just like with FDI,
gains made under portfolio investment are recorded as a plus in the current account of the foreign
nation where the investors come from but as a minus in the current account of the host nation. Under
portfolio investment, the investor will not have invested to an extent that he has influence in the
operations of the firm like with a FDI

• Capital transfers- refer to the transfer or financial resources without receiving anything in return. Eg
forgiveness of a debt by a foreign nation, conditional grants for capital projects e.g. foreign aid
earmarked to build roads, dams and schools.

• Asset transfers-transfer of tangible assets between citizens and foreigners

Overall balance of payments

• The sum of the net balance in the current account and the capital account gives us the net balance of
the balance of payments. It can be a deficit balance, a surplus balance or at a state of equilibrium.

• A surplus occurs when the income flows within the current and capital accounts of the BOPs exceed
the payments/ outflows to the rest of the world. The excess is usually in foreign currency and would
be held as foreign exchange reserve with the central bank

On the other hand, a BOPs deficit occurs when the income flows within the current and capital accounts of
the BOPs are less than the payments/ outflows to the rest of the world. The central bank would have drained
the foreign exchange reserves to enable the excess purchases. The question is what happens when the
reserves are not enough? The central bank maintains the official settlement account with the international
monetary fund (IMF). Excess foreign currency may be kept with the IMF and withdrawn when required. In
times the foreign exchange reserves are inadequate to settle a nations international payments the IMF lend
the central bank and refunds (settlement is done) when a surplus occurs.
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Balance of payment disequilibrium

This occurs when there is either deficit or surplus in the balance of payments accounts. If there is surplus,
then the country would like to maintain it because it is favorable, while if deficit, the country would like to
correct it. A Surplus balance is said to be favorable and is viewed with a lot of satisfaction. On the other
hand, a debit balance (A BOPs deficit) is said to be unfavorable and is viewed with a lot of concern because it
has the implication that we are losing more to the rest of the world than we are receiving.

“We must always take heed that we buy no more from strangers than we sell to them, for so should we
impoverish ourselves and enrich them” Sir Thomas Smith-1549, English Diplomat.

Sample balance of payments of Kenya:

Debits -outflow of income from the Kenyan economy; credits- inflow of income into the economy

Sample balance of payments of Kenya in a given year( figures in Ksh)

A.CURRENT ACCOUNT Debits Credits Balance
Exports and imports of goods and services
Kenyan exports of goods (a) 525billion
Kenyan imports of goods(b) 900billion
Visible Balance (balance of trade on goods only: (a-b) -375billion (e)
Exports of services (c) 250billion
Imports of services(d) 300billion
Balance on trade on services only (invisible balance): c-d -50billion(f)

(1) BALANCE OF TRADE (BOT) e + f -425 billion

Factor income from abroad
Income ( repatriated corporate profits)from Kenyan 300billion
investments in the diaspora(a)
Repatriated corporate profits by foreign investors in Kenya to 600billion -300billion
their home countries(b)
Dividends earned by Kenyans from shareholding in companies 250billion
in the diaspora(c)
Dividends paid to foreigners from shareholding in companies 400billion -150billion
in Kenya(d)
Total Earnings by Kenyan from employment in the diaspora 500billion
Total Earnings by foreigners from employment in the country 250billion 250billion

( 2 ) Net factor income from abroad -200 billion

(3) unilateral transfers
Remittances by Kenyans from the diaspora 150billion
Remittances by foreigners in Kenya to the diaspora 50 billion 100billion
Grants and gifts from the rest of the world 100billion
Grants and gifts to the rest of the world 50billion 50billion

(3 ) Net unilateral transfers 150billion

CURRENT ACCOUNT BALANCE (CAB) (1) + (2) + (3) -475billion

B. CAPITAL ACCOUNT
Foreign Direct Investment by foreigners into the country 150 billion
Foreign Direct Investment by Kenyans out of the country 50billion
Net Foreign Direct Investment (FDI) 100 billion
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Net Bi-lateral and multilateral commercial borrowing(loans into 250 billion 250 billion
- loans out of the country)
Net portfolio investment( portfolio in - out) 150 billion 150 billion
Net purchase of property from the rest of the world - -250billion
250billion
Net conditional foreign aid (in – out) 150 billion 150billion
250 billion
NET CAPITAL ACCOUNT BALANCE
-225 billion
Overall balance of payments- current + capital a/c balances
Status of the balance of payments: Deficit BOPs

Causes of a deficit in the Balance of payments

It may be caused by the following;

1. Fall in volume of exports, as this will reduce the earnings from exports.
2. Increase in the volume of imports, exports not increasing at the same rate.
3. Fall in demand of a country’s goods or services e.g. a decrease in tourists into our country because of
terrorism
4. Individual and government transfers out of the country being greater than those coming into the
country
5. Barriers imposed by trading partners-
6. Investment incomes being paid out being more than investment income coming in
7. More foreign direct investment outside the country than its coming into the country
8. More loans and grants to other nations than the nation is receiving
9. More remittances by foreigners to their home countries than remittances by citizens in the diaspora
back into the country.
10. Deteriorating terms of trade of a country. When there’s a fall in a country’s product export prices in
comparison to her import prices, much of the export will be required to buy a unit of the imports. The
revenue from the exports will not be enough to cover the payments for the imports. The difference
will yield a deficit in current account section of the balance of payments. This may at last affect the
overall balance
11. Restriction by a trading partner. A trading partner may restrict what they can import from a
country. Exports by the victim country fall. If the victim country does not retaliate by imposing
similar restrictions, her exports will be less than the imports from that country. The balance of trade
between the two countries will not favor the victim country and will contribute to the overall position
of balance of payments and which maybe negative.
12. Less capital inflow as compared to the out flow- outflows of capital inform of FDIs, portfolio
investments, loans to other nations, etc. maybe more than maybe more than a nation is receiving in
return. This leads to a deficit in the capital account, which may in turn leads to an overall deficit.
13. Capital flight- this refers to a large scale exodus of cash, stocks, bonds, mutual funds and bank
deposits from a nation that occurs when people lose confidence in a particular economy and
withdraw their investments from it.
14. Over valuation of the domestic currency. Valuation of a currency means fixing the exchange rate of
a domestic currency so that less of it is required in exchange for a foreign currency. This will make
the country’s export to be very expensive as compared to the imports, making it to lose market at the
world market. Eg suppose the central bank revalues the exchange rate from Ksh 80 per one US Dollar
to Ksh 70 per the same US Dollar.

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 An item worthy Ksh 56,000 will require a foreigner to part with US$ 8000 instead of US$ 7000 he
would pay before. This difference in costs from the fluctuation of the exchange rate causes the export
to become costly to the foreigners and consequently a decline in the demand of the country’s exports.
Similarly citizens may be tempted to import more because the imports become cheap. Something, say
a shirt, which would cost US$5000 would require a Kenyan to part with Ksh 350,000 and not Ksh.
400,000 as before.
15. Devaluation of the currency by the trading partner.
Suppose a trading partner like the United states of America devalues her currency relative to that of
Kenya from, say, Ksh 100 per Dollar to Ksh 50 per Dollar. Their goods (imports to us) become
attractive to us because they become cheaper than before while our products (exports) become
unattractive to them. E.g a machine that sells for US$ 500 will now go for 500x50= Sh 25,000 and not
Ksh 50,000 it would cost before. On the other hand our products become unattractive to them, e.g. a
bag of wheat of Ksh 10,000 will now cost an American Sh 10,000/50 = $ 200 and not Sh 10, 000/100=
$100 it used to cost before. Thus we buy more from them than they buy from us creating a deficit.

Correcting the balance of payment disequilibrium

The measures that may be taken to correct this may include;

1. Encouraging Foreign Direct Investment(FDI) into the country, so that it may increase the
inflow level of capital into the country/enhance the domestic production capacity so that
producing what is being imported can be produced from within and even export the surplus.
2. Restricting capital outflow from the country by decreasing the percentage of the profits that
Foreign companies in the country can repatriate back to their country to reduce the
outflow/encourage retaining of profits by multinationals.
3. Prevent capital flight- Create a conducive business and political environment within the
country to make the country attractive to investors or retain investors within the nation.
4. Devaluation of the country’s currency- make the domestic currency weaker relative to a foreign
currency so that our products become attractive to foreigners(as they become cheaper than before)
and discourage imports (as they become costlier than before). The challenge with this is that it can
make the import bill to rise when the country cannot do import substitution ( i.e. no alternative
products within the country that can be used as substitutes to the imports)
5. Decreasing the volume of imports. This will save the country from making more payments than it
receives. It can be done in the following ways:
 Imposing or increasing the import duty on the imported goods to make them more expensive
as compared to locally produced goods and lose demand locally as demand shifts in
favor of local substitutes
 Imposing quotas/total ban on imports to reduce the amount of goods that can be imported into the
country
 Foreign exchange control-restrict the amount of foreign currencies available for the imports, to
reduce the rate of importation.
 Institution of importation administrative bottlenecks- Authorities making the process
importation lengthy and cumbersome in order to discourage people from importing
goods and hence control the amount of imports
6. Increasing the volume of exports.
This enable the country to receive more than it gives to the trading partners, making it to have a
favorable balance of payments. This can be achieved through;
 Export compensation scheme- this refers to an arrangement where an exporter is allowed to claim
from the government a certain percentage of the value of goods exported. It’s intended to make them
to charge the exports at a fair price and make them competitive in the world markets and hence
increasing their demand internationally.

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  Diversifying foreign markets- so as not to concentrate only on one market (export destinations) as
well as seek to increase the volume of the exports even within the traditional markets
 Offering customs drawbacks. This refers to an arrangement where the government refunds in full
or in part, the value of the custom duties that had been charged on raw materials imported into the
country to manufacture goods for export once the finished goods from such raw materials are re-
exported.
 Lobbying for the removal of the trade restriction by a trading partner- by negotiating with their
trading partners to either reduce or remove the barriers put on their exports
 Diversification of exports- increasing volume and variety of exported goods instead of relying on
just a few.
 Form economic blocks to collectively determine the price at which to sell products member nations
happen to produce in common and defeat the existing world economic order where developed
nations dictate price and level of production with which they can buy products from LDCs( least
developed countries)

Terms of sale in international trade

In international trade, terms of sale refer to a price quotation that states the expenses that are to be borne by
the exporter and those to be borne by the importer. Such expenses include costs on loading, shipping,
insurance, off-loading, warehousing, customs duty etc. The price quoted for goods should state or indicate
the portion of costs that shall be met by the exporter before goods get to the importer. They are also called
International Chamber of Commerce Terms (INCOTERMS)

Some of the common terms include;

 Loco price/ex-warehouse/ex-works. This states that the price of the goods quoted are as they are at
the manufacturers premises. The rest of the expenses of moving the good up to the importer’s
premises will be met by the importer.
 F.O.R (Free on Rail). This states that the price quoted includes the expenses of transporting the goods
from the seller’s premises to the nearest railway station. Other railways charges are met by the
importer
 D.D (Delivered Docks)/Free Docks. This states that the price quoted covers the expenses for moving
the goods from the exporter’s premises to the dock. The importer meets all the expenses including the
dock charges
 F.A.S (Free Along Ship). States that the price quoted includes the expenses from the
exporter’s premises to the dock, including the dock charges. Any other expenses are met by
the importer
 F.O.B (Free on Board). States that the price quoted includes the cost of moving the goods up to the
ship, including loading expenses. The buyer meets the rest of the expenses
 C&F (cost & freight). The price quoted includes the F.O.B as well as the shipping costs. The importer
meets the insurance charges
 C.I.F (Cost Insurance & freight). The price includes the C&F, including the insurance
expenses
 Landed. The price includes all the expenses up to the port of destination as well as unloading charges
 In Bond. The price quoted includes the expenses incurred until the goods reaches the bonded
warehouse
 Franco (Free of Expenses). The price quoted includes all the expenses up to the importer’s premises.
The importer does not incur any other expenses other than the quoted price
 O.N.O (Or Nearest Offer). This implies that the exporter is willing to accept the quoted price
or any other nearest to the quoted one
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 Documents used in International trade

 Enquiry/Inquiry. A letter sent by an importer to the exporter asking about the goods dealt in by the
seller and their terms of sale.
 Order of Indent. Written by an importer or an importer’s agent to an exporter requiring him to
supply desired goods under specified terms and conditions. It may specify the goods to be supplied
and suggest the preferred mode of transport for them. An indent may be open or closed. In
an Open Indent the importer is not specific to the supplier about the specifications the type
of goods should adhere to. Eg an order for laptops without specifying their brand or
manufacturer. The exporter or the export agent is therefore free to choose the supplier or the
kind of goods. With a closed Indent, the importer is specific about the brand, manufacturer
and the technical aspects of the goods
 Letter of Credit. A document issued by the importer’s bank to the exporter’s bank to assure the
exporter of the payment for the goods ordered once delivered to the importer. The exporter can then
be paid by his bank on the basis of this letter.
 Import License. A document issued by the government to authorize someone to import goods from
abroad.
 Bill of Lading. A document of title to goods being exported. Issued by the shipping company to the
importer who should use it to claim goods released at the port of entry/destination. It serves three
main purposes:
 Serves as evidence that the goods were received by the shipping company
 Evidence of a contract between the ship owner and the shipper
 It’s a document of title. An importer uses it to claim for the goods as the owner once they arrive.
 Freight Note. A document prepared by the shipping company to show the transportation charges for
goods.
 Certificate of insurance. A document issued by the insurance company or agent, undertaking to
cover the risk against the loss or damage to goods being exported.
 Certificate of Origin. Document that shows the country from which goods being imported have
originated from. It’s prepared by an exporter and counter-signed by a relevant authority in the
exporting country to show country of origin of the goods. The purpose of a certificate of origin is to
enable the importer to get preferential treatment on the goods imported if the goods are from a
country that is a member of a trading bloc or is in bi-lateral agreements with the home country.
 Consular Invoice. A document that shows that the prices of the goods that have been charged is fair
as certified by the consul with the embassy of the exporting country. A copy of the invoice is sent to
the officials of the overseas port where goods are destined to. Such a copy provides the custom
officials in the importing country with reliable value of goods on which to determine import duty
payable without necessarily examining the goods in detail.
 Commercial Invoice. A document issued by the exporter to demand for the payment for the goods
sold on credit to the importer.
 The name and address of the exporter
 The name and the address of the importer
 The price charged
 The terms of sale
 The description of the consignment
 The name of the ship transporting the consignment

 Pro-forma Invoice. A document sent by the exporter to the importer if he/she is not willing to sell
goods on credit. It may be used to serve the following purposes;
a. Serve as a formal quotation
b. Serve as a polite request for payment before the goods are released for the customer
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 c. To enable the importer to initiated the clearing of the custom duty early enough to avoid
delays
d. Used to by the importer to obtain permission from the Central Bank to import goods

 An airway Bill. Issued by the airline company to show the charges for the goods being transported
 A Letter of Hypothecation. A letter written by the exporter to his/her bank authorizing it to resell the
goods being exported. This occurs if the bank fails to get payment on the bill of exchange drawn on
the importer that it has discounted for the exporter and the date of the bill has expired. Should there
be a deficit after the resale, the exporter pays the deficit
 A weight note. A documents that shows the weight and other measurements of the goods being
delivered at the docks
 A Shipping advice note. A document issued by the exporter to his/her shipping agent containing
instruction for shipping goods.

Trade Restrictions

Trade Restrictions refer to deliberate measures taken by the government to limit imports or
exports of a country. It’s also known as protectionism. Protectionism measures involve use of
tariff and non-tariff barriers that restrict free flow of goods and factors of production between
nations. A tariff is a tax imposed on imports or exports of goods by a government of a country
or a group of countries. Non- Tariff Barriers (NTBs) are trade barriers that restrict imports or
exports of goods or services through mechanisms other than use of tariffs. They include import
quotas, subsidies, customs delays, import licensing, rules for valuation of goods at customs,
pre-shipment inspections, ‘rules of origin’ etc.
Methods of trade restriction

1. Use of Tariffs- like earlier stated, tariffs are taxes levied on goods entering or leaving a
country. They are also called custom duties. Import taxes (or import duty) make the
imported product expensive to buy and hence low quantities demand. Alternatively, import
tariffs make an imported good costlier than same goods produced locally. People then
consume the locally produced good instead of the imported good. Taxes on exports are
applied when the government wants to limit outward supply of a good from an economy
that may lead to a shortage in future.

2. Quotas- this is a limitation on the quantity of goods to be either imported or exported. It can
be increased or decreased to increase or decrease the level of import or export respectively. A
total ban (zero quota) occurs when the government issues a directive illegalizing either the
import or export of the products. A zero quota is also called an embargo and is applied
mostly for political reasons. Import quotas are applied to reduce oversupply of goods within
the domestic economy which may pose excess competition forcing prices downwards and
consequently discouraging domestic producers from future production. They also promote
local production and consumption of goods produced within the economy.

3. Use of administrative bottlenecks – involves deliberately making importing lengthy and

complicated in order to discourage importers from importing. e.g. making getting the import
license complicated or deliberate delays to acquire one
4. Offering subsidies on locally produced goods to make them relatively cheaper than imports
hence discourage imports

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5. Legislation against importation of certain goods –laws intended to prevent importation of
certain goods eg. A ban on furniture imports to encourage local production and consumption
6. Setting the standards of products to be imported- enhanced specifications on the kind of
goods to be imported e.g. importing cars with a maximum of 8 years in Kenya since date of
manufacture
7. Foreign exchange control-involves restriction on the use of foreign exchange by the central
bank. Exporters have to surrender their foreign exchange earnings to the central bank. The
central bank then releases the foreign exchange only for essential imports and conserves the
rest of the balance.

Reasons for trade restrictions

 To protect the country from dumping: Dumping refers a case where a country or a company
exports a product and sells it at a lower price in a foreign country than the price of the
product in the exporter’s domestic market. It’s done so that the foreign company can
penetrate a foreign market, by charging the product at prices way below the prices charged
for the same product in the foreign country, or as a way of companies avoiding waste
disposing costs for obsolete (outdated) products in their home country.
 To prevent the inflow of harmful goods into the country, that may be harmful to the lives of
the citizen’s e.g. agricultural produce that may have had harmful pesticides applied
 To protect the local infant industries. Infant industries are newly established industries.
They may not be able to compete favorably well with products from well-established
industries and may end up collapsing.
 To give a country a chance to exploit its natural resources in producing their goods and
encourage local production and consumption
 To protect a country’s strategic industries.-strategic industries are industries considered
important for the wellbeing of a country because they contribute to livelihoods of the people
or enable value addition or running of other industries. If not guarded from external forces,
they may collapse.
 To promote sovereignty: To minimize dependency of the country on other countries for
their stability and independence in decision making.
 To preserve employment opportunities: once local companies are prevented from
collapsing, peoples jobs can be assured
 To correct deficit in the balance of payments- By limiting imports, a country may correct a
current account deficit in the BOPs, which may ultimately be contributing to an overall
deficit in the BOPs.
 To protect good cultural and social values – to protect citizens from influence by
unaccepted values they are likely to acquire from other country through interaction
 To preserve product markets for locally produced goods- by restricting the number of
foreign goods in the market so that people consume goods from internal companies.
 As a source of revenue to the government-To enable the country earn foreign exchange
through imposing taxes and other tariffs

Disadvantages of trade restrictions

 Reduced consumer choice .There will be availability of limited variety of goods in the
country that will limit the consumer’s choices.
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  Reduced quality of goods-May lead to production of low quality goods as there will be no
competition for the producing firms from elsewhere
 Possible retaliation by other goods- Other countries may also retaliate, leading to reduction
in exports from their country
 High prices for domestic output. There is likely to be high prices charged on the locally
produced goods since the small firms which produce them may not be enjoying the
economies of scale or because of lack of competition that leads to competitive prices.
 Limited market-The country is likely to be exposed to small market, should all countries
restrict trade which may lead to reduction in global trade.
 Danger of perpetual protection-Instead of taking advantage of trade restrictions intended to
give local firms time to grow, strangely most of them become complacent(relaxed) because
of lack of threat or challenge to become efficient. ‚It happens that a 20 year old firm is still an
infant‛
 It may lead to emergence of monopolies-a protected industry may end up with a single firm
in the entire market, bringing about the problems of monopolies like insensitivity to
consumer rights or prices that are not competitive.

Economic Integration

Economic Integration refers to agreements between two or more countries within a geographical
region intended to reduce or do away with tariff and non-tariff barriers that restrict trade between
the countries. Countries may remove or relax trade barriers amongst themselves while instituting,
increasing or retaining trade restrictions with non-member countries.

Forms of economic integration

Different forms exist depending on the level of extend of co-operation among member counties.
They include:

Free Trade Area (FTA)

This is the simplest form of integration. Member countries in a FTA agree to abolish or minimize
tariffs and other trade restrictions amongst themselves but the individual countries are free to
impose trade restrictions on non-member countries. They include the European Free Trade Area
(E.F.T.A), Latin America Free Trade Area (L.A.F.T.A), etc. Discussions have been in place by
African Nations to make Africa a FTA.

Custom union
Here, besides member countries agreeing to abolish or minimize tariffs and other trade restrictions
amongst themselves, they agree to impose common trade restrictions on non-member countries.
They include; Economic Community of West Africa States (E.C.O.W.A.S), East Africa Custom
Union (E.A.C.U), Central Africa Custom and Economic Union (C.A.C.E.U)

Common Market
On top of features of a customs union, member countries in a common market go ahead to allow for
free movement of factors of production across the borders. People are free to move and establish
their business in any member country. They include; East Africa Common Market (E.A.C.M),
European Economic Community (E.E.C), Central American Common Market (C.A.C.M), Common
Market for Eastern and Southern Africa (COMESA)
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Economic Union
Includes all the features of a common market plus joint economic institutions such as a joint central
bank common monetary policies and shared public infrastructure such as railways and
communication network
Example is the European Union (EU).

Importance of economic integration

Economic integration accords the following benefits for the member countries;
 Availability of wider market for the goods and services –member countries market extends
beyond their borders. They can produce at full capacity and enjoy economies of scale.
 Encourages specialization-a country can specialize in the goods or services they can
produce best and at least cost. Countries can then exchange goods produced efficiently and
at least cost.
 It leads to promotion of peace and co-existence among the member countries from
interaction and cooperation between citizens of the different countries
 High quality goods and services are produced out of specialization and enhanced
competition
 It allows members to get access to wider variety of goods and services.
 It leads to creation of employment for individuals living within the region, as they can work
in any of the member country or from growth of companies.
 It increases the economic bargaining power between the countries and other nations of the
world.
 Improvement of the infrastructure in the region due to increased economic activities.
 It brings about co-ordination when developing industries, as the members will assign the
suitable industries to each other creating balance development and avoid unnecessary
duplication.

Free Trade
This is a situation where there is unrestricted exchange of goods and services between the countries.
It has benefits/advantages similar to those of economic integration.

Disadvantages of free trade

 It may lead to exploitation of least developed countries - Least developed countries may not
be able to produce high quality and quantity to compete with those of developed countries.
 It may discourage the growth of the infant industries due to competition from well-
developed industries in other countries.
 It may lead to reduced government revenue because no tariff may be charged on the goods
and services
 If not controlled, it may lead to unfavorable balance of payment, where a country imports
than it exports.
 It may lead to importation of harmful goods and services, that may affect the members
health such as illegal drugs
 It may lead to lack of employment opportunities in a country especially where more
qualified people have moved from their country to secure job opportunities into another
country.

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 It may expose the country to negative cultural practices in other countries, interfering with
their morals. Interactions with people with varied upbringing may influence/corrupt others
morals.
 It may prevent a country from establishing its own industries because it can easily get goods
from outside. Such a country becomes import depended.
 It may lead to dumping.
 It may lead to collapse of domestic industries leading to loss of employment opportunities
 Least developed counties may never free themselves from a deficit in their balance of
payments as imports may always be greater than exports

Current Trends in International Trade

1. Liberalization of international trade. Liberalization refers to freeing of markets from state

intervention. Liberalization of international trade refers to the removal of trade restriction
among the countries so as to encourage free flow of goods between countries (promote free
trade). Trade restrictions include the tariff and non-tariff barriers as earlier seen.

Advantages of trade liberalization

a) It leads to removal of barriers that complicate international trade making trade easy
among countries
b) Low costs of goods-Elimination of barriers brings about reduced costs of imports by
importing countries/ competition makes firms check on prices
c) Increased exports- a country may export more goods to the rest of the world because
there are no barriers
d) Higher consumer choice – citizens of different countries can enjoy enhanced variety
of goods and services
e) It leads to increase in foreign direct investments- Transfer of capital, knowledge
ideas and technology among nations becomes easy.
f) It increases specialization in production- countries can specialize in what they can do
best and acquire what they can’t do best from other countries.
g) Availability of wider market for the goods and services –member countries markets
for products extend beyond their borders. They can produce at full capacity and enjoy
economies of scale.
h) High quality goods and services are produced out of specialization and enhance
competition
i) It leads to creation of employment opportunities; citizens of a country can work
anywhere/ enabled large scale production leads to more engagement of factors of
production.
j) Nations are able to enjoy economies of scale- wide market triggers mass production
that comes with reduced unit costs of doing business.
k) It eliminates inefficiency from over protected domestic firms- protectionism may
make domestic firms complacent instead of growing out of the shielding from
foreign competition

Disadvantages of liberalization of international trade

This are the same as the disadvantages of free trade discussed earlier.

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2. Development of export processing zones (EPZ)

EPZs are designated parts of a country intended for export oriented production. Firms in an
EPZ may be 100% locally owned or 100% foreign owned-there are no restrictions. Their
purpose is to promote export production and hence the country’s export earnings. Incentives
offered to investors in Kenya include a 10% corporate income tax holiday , 25% rate for a
further 10 years thereafter, a perpetual exemption of products from VAT and import duty
on inputs such as raw materials, machinery, building materials and other supplies, 24 hour
paid security, serviced land and ready factories for sale or lease etc.

Advantages of export processing zones (EPZ)

 It creates job opportunities to the citizens
 It creates market for locally produced raw materials that they use in their production
 It encourage the foreign investors to invest in the countries, i.e. in the processing zones,
increasing the level of investment in the country
 Encourages export in the country as the incentives given to them by the government makes
them to produce more and more for export
 It stimulates industrialization in the country in all sector including the ones producing for
local consumptions
 Exports enable us to have a favorable exchange rate and balance of payments
 Income earned from EPZs indirectly promotes other business within the area

Disadvantages of export processing zones (EPZ)

 Most of them are foreign owned and employs foreigners in their management team,
denying the locals a chance to get employed
 They do not generate revenue to the government, especially during tax free periods
 They are concentrated in few towns, bringing about imbalance regional development
 Some of them encourage social evils such as prostitution in areas where they are developed
3. Development of e-commerce websites

These enable buying and selling over the internet. E-commerce has the following
benefits/advantages:
 One is able to access the market worldwide, as the countries are connected to the internet
 There is no discrimination, as both the small and large industries are able to transact
through the internet
 It is fast to transact the business through internet, as it saves on travelling time and therefore
suitable for urgent transaction
 It is cheap especially on the cost of sending, receiving and storing information
 Consumers can chose what to buy and when to buy at the comfort of wherever they are
 Product data sheets enable a customer to make informed decisions on what to buy
 Customer experiences are shared as reviews. This keeps traders customer friendly and avoid
fraud as once reported it will drive them out of the platform
 Consumers are able to get information about variety available in the market
 Its less costly to firms as they don’t have to create brick and mortar branches across the
world/ country
 Consumers are able to know average prices of products in the market

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 International financial institutions

An international financial institution (IFI) is a financial institution that has been established by more than one
country and hence it’s subject to international law. Its owners or shareholders or financiers are generally
national governments.

They include

1. The Bretton Woods institution- The International Monetary Fund (IMF), the World Bank and
the International Finance Corporation (IFC). These were established after World War II to
assist in reconstruction of Europe and provide mechanism for international cooperation in
managing the global financing system
2. The African Development Bank(IDB)
3. The African Development Fund(IDF)

The International Monetary Fund (IMF)

The IMF is a major financial agency of the United Nations (UN) and an international financial institution
(IFI) headquartered in Washington DC, USA, and consisting OF 190 countries. It was formed in 1944 but
started on 27th Dec, 1945.

Functions / purpose of the IMF

1. To promote international monetary cooperation- to foster cooperation that ensures that

policies of one nation don’t undermine other nations in international trade
2. To facilitate liquidity in international trade- member countries that experience problems in
raising foreign exchange are allowed to borrow the required foreign currency from the IMF
and pay for their imports
3. To foster sustainable economic growth among nations
4. To maintain stability in exchange rates-IMF requires member countries to intervene in the
foreign exchange markets to ensure that exchange rates are within acceptable limits
5. To foster sustainable economic growth of member countries
6. To prevent/assist nations recover from international financial crisis

The international Bank for Reconstruction and Development (The World Bank)
The World Bank is an IFI that provides loans and grants to governments of low and middle income countries
for the purpose of pursuing capital projects. It’s a multilateral development bank -MDB (a bank created by a
group of countries that provides financing and professional advice to enhance development). The World
Bank is the collective name for the International Bank for Reconstruction (IBRD) and the International
Development Association (IDA), two of five international organizations owned by the World Bank Group. It
was formed alongside the IMF at the 1944 Bretton Woods Conference.

FUNCTIONS OF THE WORLD BANK

 Providing member countries with long-term capital for economic reconstruction and
development
 Inducing long term capital investments to enable countries realize favorable BOPs in
international trade

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  Providing financing, technical advice and research to developing countries for development
programs to aid their economic advancement
 Granting reconstruction loans to war devastated nations
 Providing low interest loans to governments for Agriculture, irrigation, power, transport,
water supply education etc.
 Promoting foreign direct investment by guaranteeing loans provided by other financial
institutions
 Promoting industrial development of underdevelopment countries by promoting economic
reforms
 Conductive feasibility studies on projects before projects are undertaken to ensure that they
make economic sense
 Holding regular discussions with member countries to get details of their economic
challenges and development plans

THE AFRICAN DEVELOPMENT BANK (ADB)

ADB is a regional Multilateral Development Bank (MDB) established in 1964 with its headquarters in
Abidjan, Cote d’Ivoire. Its shareholders are 53 countries in Africa as well as 24 countries in the North and
South America, Europe Asia. Its main source of finance is contribution from member countries and interest
obtained from lending out loans.

Functions of the ADB

 To provide loans for economic and social development to member countries

 To provide technical advice in planning and implementation of the development plans
 Assist member countries to appropriately exploit their resources
 To encourage co-operation among African countries in order to bring economic growth
institutions in order to bring out development especially in African countries

Answer these questions

1. Give four factors that may lead to a deficit in the current account of Kenya’s BOPs
2. Highlight four solutions to a deficit in the current account of the country’s BOPs
3. State four items that will go to the debit side of the capital account of the bops
4. State whether the following goes into the debit or credit side of the current a/c Kenya’s BOPs
a) Earnings of Kenya Airways from foreign passengers
b) Spending by Kenyans on holidays abroad
c) Sale of tea to Pakistan
d) Earnings of domestic hotels from foreign guests
e) Profits by the Standard Chartered Bank, a UK bank domiciled in Kenya
f) Dividends by Kenyans from shareholding in US companies
g) Salaries to Kenyan nurses working in the UK
h) Pension to a Kenyan retiree residing in the USA
i) Remittances by Kenyan in the diaspora to their relatives back in Kenya
5. Give four circumstances that may lead to a surplus in the capital a/c of Kenya’s BOPs
6. Give five measures that may be employed to create a surplus in our BOPs
7. Give four reasons behind protectionism
8. Give four reasons against protectionism
9. Identify five benefits that Kenya will enjoy from establishment as a free trade area

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10. Identify four current trends in international trade
11. State four non-tariff barriers to international trade
12. Highlight five measures our country can take to improve her terms of trade
13. State the document used in international trade used for these purposes:
a) To seek for approval to import from the government
b) To show that prices charged for imported goods are accurate to facilitate customs
clearance
c) To order for goods from abroad
d) To claim for goods at the port of destination
e) To assure an exporter of payments once goods arrive to the importer in the desired
form and accompanied by the requisite documents
f) For an importer to claim for preferential treatment on his goods from having imported
goods from a nation with favorable bilateral agreements
g) To enable customs clearance way before goods arrive at the port
14. Distinguish between
a) A customs union and a free trade area
b) A common market and an economic union
c) Free alongside ship ( FAS ) and Delivered Docks
d) Ex-works and Franco
e) Free on Board ( F. O. B) and CI&F
f) Bilateral trade and multilateral trade
g) Customs drawbacks and export compensation scheme
15. Explain how the use of following limit imports into a country
a) Use of import tariffs
b) Use of quotas
c) Use of subsidies
d) Foreign exchange control
e) Import substitution
16. Give four functions of (a) The World bank , (b)The IMF
17. Give four measures that may be taken to double the volume of our imports
18. Explain five forms of economic integration
19. Give four benefits of international trade to a country
20. Give four advantages of liberalization of international trade
21. Explain five benefits enjoyed from e-commerce
22. Give four reasons behind creation of EPZs
23. Give four problems that may face our country from over reliance on imports

End

Prepared by Tom Kyonda,

B.Ed. Mathematics & Economics

HOD Technical & Applied Subjects, HOS Business Studies Shine Star High School

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