1.2 International Trade and Finance as Parts of International Economics

As we have previously seen, increased international trade in goods and services and the international movement of productive resources like capital and labour are among the primary features of globalization. Associated with such international flows of products and resources is a set of international financial flows. International economics helps us to make sense of these real and financial flows. Specifically, international economics is a field of study that examines the implications of international trade in goods and services, international investment, and international lending and borrowing. Within international economics, there are two broad areas: the study of international trade and the study of international finance.

The study of international trade uses microeconomic models to examine why countries trade as well as the implications of trade for consumers, businesses, governments, the nation, and the world. Standard theories suggest that countries trade with each other because they have a comparative advantage in producing specific goods. That is, countries tend to export goods they can produce at a lower cost and import those they can only produce at a relatively high cost. Some alternative theories of trade consider product differentiation and economies of scale as important bases for trade. Since trade brings net benefits to participating countries and to the world, advocates of international trade generally argue in favour of free trade policies.

While there is broad agreement that free trade brings overall benefits, within nations that engage in free trade, some groups gain, and other groups lose. Specifically, domestic producers can suffer economic losses because of import competition and will often lobby governments for protection. The study of international trade has also identified some valid reasons for national governments to protect domestic industries from imports, such as to increase employment. Therefore, the study of international trade involves analyses of government policies such as import tariffs, non-tariff barriers, and production and export subsidies.

The study of international finance uses macroeconomic models to understand the domestic economy and the financial implications of its relationship with other countries. Therefore, international finance is concerned with financial flows among countries, reflecting trade in products, inward and outward foreign direct investment, and international borrowing and lending. Major areas of focus include the determinants of exchange rates, the performance of the economy, and the effectiveness of monetary and fiscal policies under different exchange rate systems. In international finance, macroeconomic models highlight the relationships among economic variables such as gross domestic product (GDP), unemployment, inflation, trade balances, exchange rates, and interest rates.

International economics is a special field of study in economics. Because nations are sovereign, each can adopt its own policies to serve its national interest or the interests of specific groups within the economy. As such, there is no international entity that can effectively govern the global economy. While there are international institutions (e.g., the IMF, the World Bank, the World Trade Organization) whose objectives include managing aspects of the global economy, sovereignty allows nations to ignore international rules that are inconsistent with national goals. To meet their goals, nations can implement policies related to taxation and spending, money and exchange rates, and the international movement of labour and capital. Generally, these policies are aimed at increasing a nation’s economic well-being and the standard of living of its citizens.