6. International trade

Imagine the second country Y, where there is similar process underway. Instead of breads they are producing orange juice and price and wage parameters are the same. Both countries are producing same amount of their respective products, they set prices at their employess buying power, achieve overproduction of 50% and they start to solve the problem of placing it in the neighbouring country.

Optimal variant – no profit, full passing of increased productivity to consumer

In this optimal variant of international trade we see similar results as from individual production when all profits from increased productivity are fully passed to consumers. In this case is international trade sure benefit to all as growth in productivity and specialization is enabling bigger and more versatile consumption as would be achieved in particular economies without specialization and trade.  The problem is the finding that there is no profit there at all with this optimal solution.

It is really the same as if there were 2 companies within one country and their consumers would trade their products between themselves. This system without profit is sustainable long term; the nations can trade together forever as long as they have enough natural resources for their specific production.

To realize all produced goods (services) there is no need of any additional resources, no need to take on debt, no need to tax profits and consequently redistribute through transfers. There is no need for monetary stimulus, the citizens of both countries wield with enough buying power to realize all domestic as well as imported production.

There is no trade deficit which would be causing outflows of monetary mass from one of the economies and no exchange rate discrepancies. It is an ideal win-win situation.
But let´s add the factor of profit:

Variant with profit, as usual  – no full passing of increased productivity to consumer

In this case we are getting to the situation as in the variant A) of individual company.
It is the ending of an equation, where entrepreneur trying to achieve profit is thinking of placing his overproduction in external economy as domestic consumers due to amount of redistributed salaries do not have adequate buying power for realization of all his production

The problem is that also companies in his target export country are trying to realize their production through the same strategy and so the result is increased variety of supply but still insufficient demand.

With international trade there is this additional factor of uncertainty how will the consumers decide:
Will they be consuming domestic production and import will be ignored? Will it be import, which will be favored? What will be the distribution ratio between domestic production and imports?
 Will there be increase in consumption at all and will the consumers be willing to finance it through loans?

  • If consumers will decline to finance increased supply through loans, the result will be 0 profits in global scale. Total buying power 20$ is enough to realize sales in the same amount 20$(each nation 10$), what will cover just production costs. When consumption is distributed evenly between domestic and import products or both nations will decline imports totally businesses will gain nothing at all from that export strategy.
  • If increased supply is tempting enough and citizens are trapped in additional loans, there is expansion through indebtedness which will bring temporary profits but during its repayments there comes recession which will erase profits from previous years and consumption falls below minimal desired level.
  • Specialty in international trade is the possibility to partially of fully subdue one economy by another. So far we have been thinking with assumption that consumption will be more or less equally divided between domestic production and imports, or that imports will be equally ignored. These variants are not influencing the overall structure of economy of participating countries. But imagine the situation when citizens of one country will decide to absolutely favor certain imports before its own production:

Company A can fully place part of its production in domestic economy, where there is enough buying power due to paid wages and tries to sell the rest in country B.

Company B in country B has similar intentions but because of preference of its consumers he fails and gets nothing from A and nothing from B as well, as his domestic consumers decides to prefer imports before their own goods. As he paid 10$ during production as wages, his loss is -10$.  Consumers in country B (unfaithful) at the beginning see no problem at all, they used their financial resources to buy what they wanted (from country A) and they are happy from their freedom of choice. The reasons for such preference could have many sources:

  • Subjectively perceived or objective higher quality of goods from A
  • Lower price (often only marginally lower price can influence the purchasing decisions)

Here it is important to notice that lower price can be achieved through two different ways:

Either through wages reduction or through increase in production volumes and from it stemming economies of scale.  This is often forgotten especially in today´s Europe problems where advice to some countries in problems is: You have to increase your competitiveness ! and it is meant as : Reduce your labor costs !

But in reality the success of some Northern Europe countries is not based on wage reductions but more on volume increases and consequent exports to Southern Europe as is evident in multibillion trade imbalances forming between these two groups. So becoming more competitive does not necessarily mean to cut labor costs, indeed those who provide such advice are profiting from exactly the opposite! As explained with AA variant of unsatisfied needs if domestic consumers are using just a little bit of loans the price of exported goods can be as low as desired and set to defeat any pricing of competitors in target country. The little profit in domestic country is guaranteed and majority of profits is generated through exports at whatever price. The point in this knowledge is such that getting lower prices of your production is generally not a result of wage level, but volume. But such strategy cannot be adapted by all. Doubling the production capacity of both trade partners would lead only to double supply, not double demand as well!

  •  Difference in marketing quality
  • Ownership (influence over) distributions channels

This factor is really important. To get your goods to shelves today is herculean task and if there is exceptional relation between producers and distributors, these can get exclusivity at given territory. If they gain dominance at particular market, they gain all its buying power.

Without regard of reasons of preference occurring in the next step consumers in B will discover that domestic producers that were giving them jobs and salaries(used to buy goods from A) are bust and they are jobless. Now they cannot buy domestic goods even if they wanted as their domestic production base was destroyed, jobs and skills were lost. Their only hope how to satisfy their needs is to take on further debt (as their buying power is zero)

 Situation looks like this:

The production in A as happening as usual, buying power is preserved so domestic sales are working without problems. Export to B is successful, citizens of B however had to borrow as their domestic industries were liquidated and so there is no source that would guarantee them stable addition of buying power. Loans are coming from countries where profits from A ended as well. If the banks, holding profits of company from A would not provide loans to citizens of B, company A would not manage to sell any goods apart from domestic market (which has capacity just 10$) which means there would be no profit for A. The circle of international trade would stop and situation would be such that export orientated successfull company in country A would stay without any profit and country B without any industry, totally ruined. Therefore, there is eminent interest for that circle to continue.