CHAPTER 1
INTRODUCTION TO INTERNATIONAL TRADE
No country is completely self-sufficient. No country can produce all products it needs, nor is blessed with all natural resources necessary to maintain its economic growth. The resulting interdependence of nations is becoming more important as the world economy is being globalized and businesses are expanding their markets beyond their countries' borders.
Import is a business activity that brings foreign goods and services into the country where the business is located. On the other hand, export is a business activity sending goods and services beyond a nation's border. Import and export are also called international trade or foreign trade.
1. Classical theories of International trade
(1) Mercantilism
Mercantilism advocates more exports and fewer imports. A nation becomes richer and more powerful when it exports more than it imports. The trade balance between imports and exports is settled by precious metals such as gold and silver. The more precious metals a country accumulates, the more prosperous it becomes. However, not all nations can have a trade surplus for the same time period, since a nation's surplus is another nation's deficit. This theory was popular among European countries during the sixteenth to eighteenth century. While promoting exports, countries raised trade barriers to discourage imports that resulted in reduced international trade after all.
Nowadays no country admits it is implementing the mercantilism as its trade policy. More often, it is used when a country accuses other country which exports a lot but imports much less with import restrictions.
(2) absolute advantage
In 1776 Adam Smith of Great Britain published the book entitled An Inquiry into the Nature and Causes of the Wealth of Nations . In this book, he proclaimed that a country's wealth consists of the goods and services available to its citizens rather than gold and silver. He denounced mercantilism and advocated free trade.
To increase the wealth of nations, instead of producing all items a country needs, it should produce and export goods at an absolute advantage, and import goods at an absolute disadvantage. The international specialization in production would result in more outputs to all trading partners.
Some countries have a 'Natural Advantage' at some products due to climate and natural resources such as Saudi Arabia in petroleum. Other countries have an 'Acquired Advantage' at other products due to product and process technology such as Japan in electronic goods.
Let's assume that the countries of Mexico and the U.S.A. each have 100 resources available for producing tomatoes and beans. In producing 1 ton of tomatoes, Mexico uses 4 units of resource and the U.S.A. uses 10 units of resource. In producing 1 ton of beans, Mexico uses 20 units of resource and the U.S.A. uses 2 units of resource.
Mexico USA
Resources available 100 100
To produce 1 ton of tomatoes 4 10
To produce 1 ton of beans 20 2
When each uses half of its resources (50) per product without trade
Mexico USA Total Total
Tomato production 12.5 5 = 17.5 tons
Bean production 2.5 25 = 27.5 tons
When each uses all its resources (100) only for product at an absolute advantage
Mexico USA Total Total
Tomato production 25 0 = 25 tons
Bean production 0 50 = 50 tons
It is more beneficial that the USA produces only beans at an absolute advantage using all 100 resources, while Mexico produces only tomatoes at an absolute advantage using all 100 resources.
Then, one country exports a product it produces and imports a product it does not produce.
(3) Comparative Advantage
In 1817 David Ricardo expanded the Absolute Advantage Theory of Adam Smith. He declared in his book On the Principles of Political Economy and Taxation that even when a country does have or does not have an absolute advantage on all of its products, trade gains can occur if the country specializes in the production and export of products at a comparative advantage which is a greater advantage than other products, and imports products for which the advantage is less. The reason is that a country must give up less efficient production in order to allocate more resources to more efficient production due to limited resources. The comparative advantage theory has been a basis for export-oriented economic development of less developed countries.
Mexico USA
Resources available 100 100
To produce 1 ton of tomatoes 2 10
To produce 1 ton of beans 4 8
When each uses half of resources (50) per product without trade
Mexico USA Total
Tomato production 25.00 5.00 = 30.00 tons
Bean production 12.50 6.25 = 18.75 tons
When Mexico produces tomatoes and USA beans only and trade
Mexico USA Total
Tomato production 50.00 0.00 = 50.00 tons
Bean production 0.00 12.50 = 12.50 tons
In this situation, USA and Mexico together produce more tomatoes by 20 tons (50 tons-30 tons) but less beans by 6.25 tons (12.50 tons-18.75 tons). The advantage cannot be compared at this stage, because the result is more production in one product and less production in another product.
Therefore, to make a comparison easier, let's assume that the USA produces 12.50 tons of beans using all 100 resources (100 / 8), while Mexico produces 30 tons of tomatoes by using 60 resources (60 / 2). Then, Mexico can produce 10 tons of beans with the remaining 40 resources (40 / 4).
Mexico USA Total
Tomato production 30.00 0.00 = 30.00 tons
Bean production 10.00 12.50 = 22.50 tons
In this case, the USA and Mexico produce 30 tons of tomatoes and 22.50 tons of beans together. The result is that the production of beans is increased by 3.75 tons (22.50 -18.75).
For more analysis, let's assume once again that the USA produces the same 12.50 tons of beans using all 100 resources and Mexico produces 6.25 tons of beans by using 25 resources (25 / 4) to make the total production of beans by two countries 18.75 tons. Mexico can use the remaining 75 resources in producing 37.50 tons of tomatoes (75 / 2).
Mexico USA Total
Tomato production 37.50 0.00 = 37.50 tons
Bean production 6.25 12.50 = 18.75 tons
In this assumption, USA and Mexico can produce more tomatoes by 7.50 tons (37.50-30.00), while producing the same 18.75 tons of beans.
Therefore, in order to increase overall production of tomatoes and beans, it is more beneficial that the USA produces only beans at which it has a comparative advantage and Mexico produces only tomatoes at which it has a comparative advantage, even though Mexico has absolute advantages at both tomatoes and beans. Then, each country exports the product it produces and imports the product it does not produce.
Ricardo's Law of Comparative Advantage was developed under the assumption that (1) a country has limited resources so that it must allocate its resources, (2) transportation cost of products from one country to another is not considered, and (3) there is no mobility of resources between countries.
2. Interactions between an Exporter and an Importer
An importer who wants to import a product sends an inquiry to an overseas supplier. The letter of inquiry usually consists of a short introduction of the inquirer, the name and quantity of the product an importer wants to import, and the time of shipment he desires. The importer also inquires an exporter about the price, the terms of trade, the terms of payment required, and sometimes the minimum quantity the exporter is willing to accept.
If an importer responds to an exporter's advertisement or sales letter, or is referred to the exporter by an important person or organization, it is beneficial to mention this. In any case, an importer must have a specific inquiry about the products he wants to import. Too general an inquiry on any or all products a manufacturer exports will not receive special attention and as a result, the importer might not get even a reply from the exporter.
When an exporter receives an inquiry from a potential importer, the exporter sends his offer to the overseas importer. An offer usually consists of a description of the product, price with terms of trade, quantity, the time of shipment, and terms of payment. The exporter answers all the questions raised by the importer. An offer with a validity date is called a firm offer. When a firm offer is accepted by an importer, the exporter must comply with all the terms and conditions he proposed.
When an importer receives an offer from his overseas exporter, the importer first must determine if the price and other trade terms are acceptable to him. It is common for an importer to ask for discount or change in the trade terms. Sometimes an importer sends an exporter a counter-offer that contains the terms and conditions an importer is willing to accept. After several negotiations, the importer sends his acceptance of the exporter's offer and a written purchase order to the exporter.
Unless the transaction is between related parties or firms of a long-standing relationship, an exporter usually will not fulfill the purchase order without an assurance of the payment for the products he will ship. In international trade, unlike in a domestic transaction, a letter of credit (L/C) opened by the importer's bank is usually required by the exporter. Most manufacturers in developing countries are reluctant even to start the manufacturing processes until a letter of credit is received. Therefore, a letter of credit needs to be opened not when the product is ready to ship, but when the purchase order is placed and the manufacturing process begins.
When the product an importer ordered is shipped on the vessel, an ocean bill of lading (B/L) is issued to the exporter. The bill of lading carries the title to the products. The shipping lines do not release the cargo without an original bill of lading at the port of importation. An exporter obtains the bill of lading from the shipping company after shipment of the ordered goods and prepares other shipping documents required by his buyer in the letter of credit. The exporter then presents the shipping documents to his bank for payment for the products he has shipped.
The bank that receives the shipping documents first forwards the documents to the opening bank for payment. After payment for shipment is received, the exporter's bank pays the exporter. Depending on the reimbursement condition of the letter of credit, sometimes the exporter's bank first pays the exporter and forwards the shipping documents to the opening bank and gets reimbursed. In this case, the interest for the period between payment to the exporter and reimbursement is charged to the exporter. When an exporter gets paid for the product he has shipped, the international transaction is completed between an exporter and an importer.
However, an importer must wait for the vessel to arrive at the port of importation, even if the payment for his import has been made earlier against the shipping documents specified in the letter of credit. After the cargo arrives at his port, the importer's customs broker clears the goods through customs and get the shipment released by the carrier upon presentation of the bill of lading.
After customs clearance, the imported cargo goes through a distribution channel. The cargo is shipped to the importer's domestic buyers or importer's warehouse for future distribution. An importer's work is not complete until he sells his imported goods to domestic buyers and receives payment.
CHAPTER 2
ESTABLISHING AN IMPORT BUSINESS
1. reasons for Importation
Import is a business where profit is a major reason for existence. When a businessman finds products overseas which are not available in his country, he may import them for resale in his country. For example, the fruits of South America and Australia/New Zealand are imported into the United States during the winter season. Ethnic foods and specialty products are also imported into the United States when they are not available in the United States.
When a businessperson is interested in products which are available overseas and in his own country, overseas prices of similar quality should be cheaper than domestic prices for importation to be profitable. Many consumer goods imported from developing countries belong to this category. Although their quality is not equal to U.S. products, due to the cheaper prices, they are able to capture the U.S. consumer markets.
Even though prices of imported goods are higher than domestic products, if imported goods' quality is better than domestic products, importing makes sense. Luxury items catering to high-income buyers come under this category. For instance, European luxury automobiles and Japanese electronic products are in big demand because of their better quality.
In the case of high priced machinery or a factory project that requires large capital, the availability of financing plays a more important role. Foreign governments that want to promote their exports are willing to provide much better financing to importers of their products than domestic sources. Similar to the United States, most countries have an Export-Import Bank whose major function is to finance their major exports.
2. requirements for a Successful Import Business
Like any other business, without buyers of imported goods, the import business cannot exist. Selling ability by an importer himself or his salesmen is the backbone of a successful import business. "Sell first, import later" should be a motto for all beginning importers. No matter how attractive the foreign products appear to an importer, he should find buyers first before importing them.
After sales are made, an importer must deliver the goods to his buyers on time. He must have reliable suppliers who provide goods on time in accordance to the specifications. Incorrect merchandise and late deliveries can easily ruin an importer's business.
In the import business, an importer pays his supplier before receiving the goods through a bank's letter of credit, but only gets paid after delivering the goods to domestic buyers. Without a good financing ability, an import business cannot be successful.
An import business is conducted by two parties located far away from each other and with different business practices. All imports are subject to customs regulations and other governmental controls depending on the nature of the goods. Knowledge of import procedures and regulations is vital for an importer to avoid pitfalls. Importing is not an easy business nor does it yield a quick result. It is not expected to be successful in one trial or two. It requires persistence and perseverance even after several failures.
Business transactions even within the same country, require clear communication between parties. Important matters must be in writing. In the importing business, clear communication is further required between an importer and exporter of different countries using different languages.
An importer is a go-between. He must build trust with both buyers and suppliers. He must deliver the goods to the buyers on time and in strict compliance with the specifications. In order to succeed, he must have good reliable suppliers. He must perform the duties promised to the suppliers such as opening a letter of credit on a timely basis. Building trust with buyers and suppliers leads to a lasting success.
3. Legal Forms of a Business
An import business can be conducted as a sole proprietorship, a partnership, a corporation or a limited liability company (LLC).
(1) Sole proprietorship
A businessman can conduct his import business as a sole owner. All that is legally required is a business license issued by the local city government where the business is located. If the businessman wants to use a business name other than his legal name, then the fictitious name must be registered with the county government and advertised three times in the local newspaper. A newspaper usually registers the fictitious name with the county on behalf of the applicant for a business license, if he buys advertisements from the same newspaper.
As to the business tax, some cities charge a fixed amount per employee, while other cities levy a percentage of the gross sales amount. The individual has unlimited liability for his business activities. Federal and state income taxes for business income are paid as the owner's individual income.
(2) Partnership
When more than one legal entity forms a business, it becomes a partnership. A partnership is also required to register its fictitious name with the county government. There are two kinds of partnership:
(a) General Partnership
All partners are general partners who have unlimited liability for the business activities like a sole proprietorship.
