BBA 1ST SEM/ 1ST YEAAR

MACRO ECONOMICS (BM111)

(UNIT-5)

INTERNATIONAL
TRADE
International trade is referred to as the exchange or trade of goods and services between
different nations. This kind of trade contributes and increases the world economy. The most
commonly traded commodities are television sets, clothes, machinery, capital goods, food,
and raw material, etc.,
International trade has increased exceptionally that includes services such as foreign
transportation, travel and tourism, banking, warehousing, communication, advertising, and
distribution and advertising. Other equally important developments are the increase in foreign
investments and production of foreign goods and services in an international country. This
foreign investments and production will help companies to come closer to their international
customers and therefore serve them with goods and services at a very low rate.
All the activities mentioned are a part of international business. It can be concluded by saying
that international trade and production are two aspects of international business, growing day
by day across the globe.
Foreign trade is exchange of capital, goods, and services across international borders or
territories. In most countries, it represents a significant share of gross domestic product
(GDP). While international trade has been present throughout much of history, its economic,
social, and political importance has been on the rise in recent centuries.

Image Courtesy : tradegov.files.wordpress.com/2012/05/wtw-2012-old-style.jpg

According to Wasserman and Haltman, “International trade consists of transaction
between residents of different countries”.
According to Anatol Marad, “International trade is a trade between nations”.
According to Eugeworth, “International trade means trade between nations”.

Difference between Trade and Commerce

 BASIS TRADE COMMERCE

Meaning The possession of goods or Commerce involves all the

services is given from one activities that aid in promoting the
person to the another in exchange of goods and services
payment of cash or cash from the manufacturer to the last
equivalents. Trade can be customers. Primarily, the activities
performed between 2 are banking, transportation,
parties or more than 2 advertising, warehousing,
parties. insurance, etc.,

Scope Narrow Broad

Type of Social Economic

Activity

Association Between the buyer and Between the manufacturer and

seller customer

Capital More Less

requirement

Frequency of Isolated Regular

Transactions

 Classification of International Trade:

(a) Import Trade:
It refers to purchase of goods from a foreign country. Countries import goods which are not
produced by them either because of cost disadvantage or because of physical difficulties or
even those goods which are not produced in sufficient quantities so as to meet their
requirements.

(b) Export Trade:

It means the sale of goods to a foreign country. In this trade the goods are sent outside the
country.

(c) Entrepot Trade:

When goods are imported from one country and are exported to another country, it is called
entrepot trade. Here, the goods are imported not for consumption or sale in the country but
for re- exporting to a third country. So importing of foreign goods for export purposes is
known as entrepot trade.

 Characteristics of International Trade:

(i) Separation of Buyers and Producers:
In inland trade producers and buyers are from the same country but in foreign trade they
belong to different countries.

(ii) Foreign Currency:

Foreign trade involves payments in foreign currency. Different foreign currencies are
involved while trading with other countries.

(iii) Restrictions:
Imports and exports involve a number of restrictions but by different countries. Normally,
imports face many import duties and restrictions imposed by importing country. Similarly,
various rules and regulations are to be followed while sending goods outside the country.

(iv) Need for Middlemen:

The rules, regulations and procedures involved in foreign trade are so complicated that there
is a need to take the help of middle men. They render their services for smooth conduct of
trade.

(v) Risk Element:

The risk involved in foreign trade is much higher since the goods are taken to long distances
and even cross the oceans.

(vi) Law of Comparative Cost:

A country will specialise in the production of those goods in which it has cost advantage.
Such goods are exported to other countries. On the other hand, it will import those goods
which have cost disadvantage or it has no specific advantage.

(vii) Governmental Control:

In every country, government controls the foreign trade. It gives permission for imports and
exports may influence the decision about the countries with which trade is to take place.

 Need for International Trade:

In today’s world, economic life has become more complex and diversified. No country can
live in isolation and claim to be self-sufficient. Even countries with different ideologies,
culture, and political, social and economic structure have trade relations with each other.
Thus, trade relations of U.S.A. with U.S.S.R. and China with Japan are examples. The aim of
international trade is to increase production and to raise the standard of living of the people.
International trade helps citizens of one nation to consume and enjoy the possession of goods
produced in some other nation.
  Reasons of International Trade:
1- Reduced dependence on your local market

Your home market may be struggling due to economic pressures, but if you go global, you
will have immediate access to a practically unlimited range of customers in areas where there
is more money available to spend, and because different cultures have different wants and
needs, you can diversify your product range to take advantage of these differences.

2- Increased chances of success

Unless you’ve got your pricing wrong, the higher the volume of products you sell, the more
profit you make, and overseas trade is an obvious way to increase sales. In support of this,
UK Trade and Investment (UKTI) claim that companies who go global are 12% more likely
to survive and excel than those who choose not to export.

3- Increased efficiency

Benefit from the economies of scale that the export of your goods can bring – go global and
profitably use up any excess capacity in your business, smoothing the load and avoiding the
seasonal peaks and troughs that are the bane of the production manager’s life.

4- Increased productivity

Statistics from UK Trade and Investment (UKTI) state that companies involved in overseas
trade can improve their productivity by 34% – imagine that, over a third more with no
increase in plant.

5- Economic advantage

Take advantage of currency fluctuations – export when the value of the pound sterling is low
against other currencies, and reap the very real benefits. Words of warning though; watch out
for import tariffs in the country you are exporting to, and keep an eye on the value of
sterling. You don’t want to be caught out by any sudden upsurge in the value of the pound,
or you could lose all the profit you have worked so hard to gain.

6- Innovation

Because you are exporting to a wider range of customers, you will also gain a wider range of
feedback about your products, and this can lead to real benefits. In fact, UKTI statistics show
that businesses believe that exporting leads to innovation – increases in break-through
product development to solve problems and meet the needs of the wider customer base. 53%
of businesses they spoke to said that a new product or service has evolved because of their
overseas trade.
7- Growth

The holy grail for any business, and something that has been lacking for a long time in our
manufacturing industries – more overseas trade = increased growth opportunities, to benefit
both your business and our economy as a whole.

8. Uneven Distribution of Natural Resources:

Natural resources of the world are not evenly divided among the nations of the world.
Different countries of the world have different amount of natural resources and they differ
with each other in regard to climate, minerals and other factors.

Some countries can produce more of sugar like Cuba, some can produce more of cotton like
Egypt, while there are some others which can produce more of wheat like Argentina. But all
these countries need sugar, cotton and wheat. So they have to depend upon one another for
the exchange of their surpluses with the goods that are in short supply in their country and
hence the need for international trade is natural.

9. Division of Labour and Specialisation:

Due to uneven distribution of natural resources, some countries are more suitably placed to
produce some goods more economically than other countries. But they are geographically at a
disadvantageous position to produce other goods. They specialise in the production of such
goods in which they have some natural advantage in the form of availability of raw material,
labour, technical know-how, climatic conditions, etc. and get other goods in exchange for
these goods from other countries.

10. Differences in Economic Growth Rate:

There are many differences in the economic growth rate of different countries. Some
countries are developed some are developing, while there are some other countries which are
under-developed: these under-developed and developing countries have to depend upon
developed ones for financial help, which ultimately encourages international trade.

 Advantages and Disadvantages of International Trade

 Advantages of International Trade:
(i) Optimal use of natural resources:
International trade helps each country to make optimum use of its natural resources. Each
country can concentrate on production of those goods for which its resources are best suited.
Wastage of resources is avoided.

(ii) Availability of all types of goods:

It enables a country to obtain goods which it cannot produce or which it is not producing due
to higher costs, by importing from other countries at lower costs.

(iii) Specialisation:
Foreign trade leads to specialisation and encourages production of different goods in different
countries. Goods can be produced at a comparatively low cost due to advantages of division
of labour.

(iv) Advantages of large-scale production:

Due to international trade, goods are produced not only for home consumption but for export
to other countries also. Nations of the world can dispose of goods which they have in surplus
in the international markets. This leads to production at large scale and the advantages of
large scale production can be obtained by all the countries of the world.

(v) Stability in prices:

International trade irons out wild fluctuations in prices. It equalizes the prices of goods
throughout the world (ignoring cost of transportation, etc.)

(vi) Exchange of technical know-how and establishment of new industries: Underdeveloped

countries can establish and develop new industries with the machinery, equipment and
technical know-how imported from developed countries. This helps in the development of
these countries and the economy of the world at large.

(vii) Increase in efficiency:

Due to international competition, the producers in a country attempt to produce better quality
goods and at the minimum possible cost. This increases the efficiency and benefits to the
consumers all over the world.

(viii) Development of the means of transport and communication:

International trade requires the best means of transport and communication. For the
advantages of international trade, development in the means of transport and communication
is also made possible.

(ix) International co-operation and understanding:

The people of different countries come in contact with each other. Commercial intercourse
amongst nations of the world encourages exchange of ideas and culture. It creates co-
operation, understanding, cordial relations amongst various nations.

(x) Ability to face natural calamities:

Natural calamities such as drought, floods, famine, earthquake etc., affect the production of a
country adversely. Deficiency in the supply of goods at the time of such natural calamities
can be met by imports from other countries.

(xi) Other advantages:

International trade helps in many other ways such as benefits to consumers, international
peace and better standard of living.
  Disadvantages of International Trade:
Though foreign trade has many advantages, its dangers or disadvantages should not be
ignored.

(i) Impediment in the Development of Home Industries:

International trade has an adverse effect on the development of home industries. It poses a
threat to the survival of infant industries at home. Due to foreign competition and unrestricted
imports, the upcoming industries in the country may collapse.

(ii) Economic Dependence:

The underdeveloped countries have to depend upon the developed ones for their economic
development. Such reliance often leads to economic exploitation. For instance, most of the
underdeveloped countries in Africa and Asia have been exploited by European countries.

(iii) Political Dependence:

International trade often encourages subjugation and slavery. It impairs economic
independence which endangers political dependence. For example, the Britishers came to
India as traders and ultimately ruled over India for a very long time.

(iv) Mis-utilisation of Natural Resources:

Excessive exports may exhaust the natural resources of a country in a shorter span of time
than it would have been otherwise. This will cause economic downfall of the country in the
long run.

(v) Import of Harmful Goods:

Import of spurious drugs, luxury articles, etc. adversely affects the economy and well-being
of the people.

(vi) Storage of Goods:

Sometimes the essential commodities required in a country and in short supply are also
exported to earn foreign exchange. This results in shortage of these goods at home and causes
inflation. For example, India has been exporting sugar to earn foreign trade exchange; hence
the exalting prices of sugar in the country.

(vii) Danger to International Peace:

International trade gives an opportunity to foreign agents to settle down in the country which
ultimately endangers its internal peace.

(viii) World Wars:

International trade breeds rivalries amongst nations due to competition in the foreign markets.
This may eventually lead to wars and disturb world peace.

(ix) Hardships in times of War:

International trade promotes lopsided development of a country as only those goods which
have comparative cost advantage are produced in a country. During wars or when good
relations do not prevail between nations, many hardships may follow.

The Role of Trade in Economic Development:

In discussing the role of trade in fostering economic development, we have to examine
various different issues, viz, the static effects of trade, the dynamic effects of trade and export
pessimism or secular deterioration of the terms of trade of LDCs. In this context, we have
access to discuss trade policies of the developing countries.

1. The Static Effect of Trade on Economic Development:

International trade enables an LDC to get beyond its PPC and improve its welfare. It can
consume more than what it is capable of producing through specialisation and exchange. An
LDC can improve its well-being by specialising in and exporting the relatively less expensive
domestic goods and importing goods which are relatively more expensive. Even if a
country’s production does not change at all, there are still gains from exchange if there is a
difference between internal relative prices in autarky and those which can be obtained
internationally.

In addition, the characteristics of the imported goods either in terms of quantity for customers
or productivity in the case of capital and intermediate imports, may improve the economy ‘s
ability to meet consumer desires for better quality goods or larger volume of goods made
available by improved technology. Imports may also help remove bottlenecks and enable the
economy to operate closer to its PPC—that is to say, more efficiency on a consistent basis.

i. Employment Generation:
Due to specialisation there is a relative expansion of the sectors using relatively more
intensively an LDCs abundant factor—which is labour. For most LDCs, specialisation
according to comparative advantage helps to expand labour-intensive production instead of
more modern, capital-intensive production.

This means expanding traditional agriculture, primary products, and labour-intensive light
manufactures. International trade thus stimulates employment and puts upward pressure on
wages as has been suggested by the Heckscher-Ohlin (H-O) theorem. However, most LDCs
are labour-surplus countries. So, an increased demand for labour is unlikely to raise the wage
rate much.

ii. Export Instability:

Moreover, the relative growth in the production of traditional goods may not be desirable if
such growth is at the expense of modern manufacturing. Due to low income and price
elasticities of demand for such goods and the instability of supply of agricultural and primary
products due to natural (weather) conditions, greater specialisation in these goods can result
in a greater instability of income even in the short run.

iii. Adverse Terms of Trade:

In addition, since an LDC is a small country (in the sense that it cannot exert any influence on
the prices of its exports and imports), expansion of export supply may lead to undesired terms
of trade movements that will-reduce the static gains from trade. This may lead to a
distribution of gains from trade in favour of the industrially developed countries.
iv. Greater Dependency:
Finally, expanding production of basic labour-intensive goods and relying on the
industrialised countries for technology and skill-intensive manufactures and capital goods
often leads to excessive economic dependency. It also links the economic health of the
developing country to that of the industrialised country.

v. Vent for Surplus:

Both the classical (Ricardian) and the modern (H-O) theories of international trade are based
on the assumption that production in each trading country takes place under conditions of full
employment. But full employment does not prevail in LDCs. So, trade theories cannot be
applied in such countries to predict the impact of trade on production, consumption,
distribution and social welfare.

Yet, there is another potential gain from trade, as has been pointed out by Hla Myint (1958).
According to Myint, due to unemployment on LDCs, actual output is less than its potential
output. By utilising its manpower fully an LDC can produce more products and its supply
may exceed domestic demand.

This excess supply can be disposed of in the form of export. In this sense a ‘vent for surplus’,
i.e., a larger market that will permit a labour surplus country to increase its employment and
output, as is shown by a movement from a point such as I (inefficient point), inside the PPC
to a point E (efficient point) on the PPC in Fig. 1.

Myint suggests that vent for surplus convincingly explains why countries start to trade, while
the theory of comparative cost helps to understand the types of commodities countries
ultimately export and import. No doubt the gains in income, employment and needed imports
can render considerable help to the whole process of development.

In short, the static gains from trade for an LDC originates from the traditional gains from
exchange and specialisation as will follow from a vent for surplus. However, due to the lack
of sufficient flexibility in traditional (largely subsistence) economies and the nature of the
traditional labour-intensive exports, the relative gains from trade may be less than those from
more flexible and progressive industrial economies and may be further reduced by the
undesirable effects of increased economic instability and secular deterioration of the terms of
trade. No doubt in the process of economic development we find changes in the economic
structure and sectoral distribution of income.

This occurs in response to changes in relative prices brought about by international trade.
However, the economic systems of the LDCs tend to be somewhat unresponsive to changing
price incentives, at least in the short run.

So, factors of production may not move easily to the expanding low-cost sectors from the
contracting higher-cost sectors. In such a situation the process of adjustment assumes the
characteristics of the specific-factors model. Consequently, the gains from specialisation are
reduced correspondingly.

2. The Dynamic Effects of Trade on Economic Development:

Perhaps the maximum potential impact of trade on development lies in its dynamic effects.
As D. Salvatore has put’ it- “While the need for a truly dynamic theory cannot be denied,
comparative statics can carry us a long way forward incorporating dynamic changes in the
economy into traditional trade theory. As a result, traditional trade theory, with certain
qualifications, is of relevance even for developing nations and the development process.”

On the positive side, the expansion of output made possible by access to the wider
international markets enables the LDC to exploit economies of scale that would not be
possible with a narrow domestic market.

This means that industries which are not internationally competitive in an isolated market
may achieve competitiveness by way of international trade if there are potential economies of
scale. If LDCs can take advantage of economies of scale, they can reduce costs of production
and sell their products at low prices in international market.

Promotion of Infant Industries:

Moreover, comparative advantage is a dynamic concept. In the real world, we find changing
pattern of comparative advantage over time. As a developing nation accumulates capital and
improves its technology, its comparative advantage shifts away from primary products to
simple manufactured goods first and then to more sophisticated ones.

Thus, with economic development, international trade can foster the development of infant
industries and make them internationally competitive by providing the market size and
exposure to products and processes that is unlikely to happen in closed (isolated) economy.
This is why the most important argument for protection in LDCs is the infant industry
argument. It is essentially an argument in favour of protection to gain comparative advantage.

This is why for protecting infant industries trade policy restraints in most LDCs are used, at
least in the early stages to restrict imports or promote exports. To some extent, this has
already happened in Brazil, Korea, Taiwan, Mexico and some other developing countries.
However, there are various problems with using the policy in practice. Infants never grow
adult in some high protected environments and there is need for continuation of protection for
ever.

Other Dynamic Influences:

Perhaps the maximum possible impact of trade on development depends on its dynamic ef-
fects. Prima facie, the expansion of output brought along by access to the larger international
markets permits the LDC to take advantage of economies of scale that do not arise in the
limited domestic market.

Thus, industries which are not internationally competitive in a narrow and isolated domestic
market may well gain competitiveness as a wider market created by international trade. Trade
creates an opportunity to exploit potential economies of scale. Furthermore, comparative
advantage keeps on changing over time.

Thus, as economic development takes place, international trade promotes the growth and
ensures the maturity of infant industries which become internationally competitive by being
able to exploit the wider market created by trade.

A wider market also exposes an LDCs products and processes in international market and
creates pressure on the industries of LDCs to improve product quality and reduce product
price so that these are accepted in the rest of the world. In short, international trade makes
protected domestic industries internationally competitive.

Other dynamic influences of trade on economic development arise from the positive com-
petitive effects of trade, increased investment resulting from changes in the economic
environment; the increased dissemination of technology into the LDC (as has been suggested
by the product life cycle model), exposure to new and improved products and changes in
institutions accompany the increased exposure to different countries, cultures and products.
Trade fosters domestic competition and acts as an instrument of controlling monopoly.

Openness to trade can affect the technology that a-country can use. We may now discuss the
mechanism in detail. Trade policies give of country access to new and improved products. No
doubt capital goods are an important type of input into production that is largely imported by
LDCs at lower stages of development. Trade allows a country to import new and improved
capital goods, which “embody” better technology that can be used in production to raise
total factor productivity.
The foreign exporters can also enhance the process, for instance, by advising the importing
firms on the best ways to use the new capital goods. Some empirical studies show that the
gains from being able to import unique foreign imports that embody new technology can be
larger than the traditional gains from trade, highlighted by the classical theory.

According to T. A. Pugel, in a more general way, openness to international activities leads

the firms and people of the country to have more contact with technology developed in other
countries. This greater awareness makes it possible for an LDC to gain the use of new
 technology—through purchase of capital goods or through licensing or initiation of the technology.

Great economic openness is likely to have a favourable effect on the incentive to innovate. Trade is
likely to put additional competitive pressure on the country’s firms. The pressure drives the firms to
seek better technology to raise their productivity in order to achieve greater international
competitiveness.

Trade also provides a larger market in which to earn returns to innovation. Its sale into foreign
markets provides additional returns, then the incentive to innovate increases, and firms devote
more resources to R & D activities.

Openness thus can enhance the technology that a country can use—both by facilitating the
diffusion of imported technology into the country and by accelerating the indigenous development
of technology. Furthermore, these increases in current technology base can be used to develop
additional innovations in the future.

The current technology base becomes a potent source of increasing returns over time to ongoing
innovation activities. The growth rate for the country’s economy (and for the world as a whole)
increases in the long run.

In short, economic openness can accelerate long-run economic growth. This indicates an additional
source of gains from international trade (or from openness to international activities more
generally). Empirical studies show that there is a strong positive correlation between the growth
rate of a country and its international openness. This is not a proof of causation, ‘but it is consistent
with the theoretical analysis that suggests why openness can raise growth.

TERMS OF TRADE (TOT)

Terms of trade (TOT) represent the ratio between a country's export prices and its import prices. How many
units of exports are required to purchase a single unit of imports? The ratio is calculated by dividing the price
of the exports by the price of the imports and multiplying the result by 100. When more capital is leaving the
country then is entering into the country then the country’s TOT is less than 100%. When the TOT is greater
than 100%, the country is accumulating more capital from exports than it is spending on imports.
KEY TAKEAWAYS
 Terms of trade (TOT) is a key economic metric of a company's health measured through what it
imports and exports.
 TOT is expressed as a ratio that reflects the number of units of exports that are needed to buy a single
unit of imports.
 TOT is determined by dividing the price of the exports by the price of the imports and multiplying the
number by 100.
 A TOT over 100% or that shows improvement over time can be a positive economic indicator as it can
mean that export prices have risen as import prices have held steady or declined.
The TOT is used as an indicator of a country’s economic health, but it can lead analysts to draw the wrong
conclusions. Changes in import prices and export prices impact the TOT, and it's important to understand
what caused the price to increase or to decrease. TOT measurements are often recorded in
an index for economic monitoring purposes.
An improvement or increase in a country's TOT generally indicates that export prices have gone up as import
prices have either maintained or dropped. Conversely, export prices might have dropped but not as
significantly as import prices. Export prices might remain steady while import prices have decreased or they
might have simply increased at a faster pace than import prices. All these scenarios can result in an improved
TOT.
 Factors Affecting Terms of Trade
A TOT is dependent to some extent on exchange and inflation rates and prices. A variety of other factors
influence the TOT as well, and some are unique to specific sectors and industries.
Scarcity—the number of goods available for trade—is one such factor. The more goods a vendor has
available for sale, the more goods it will likely sell, and the more goods that vendor can buy
using capital obtained from sales.
The size and quality of goods also affect TOT. Larger and higher-quality goods will likely cost more. If goods
sell for a higher price, a seller will have additional capital to purchase more goods.
Fluctuating Terms of Trade
A country can purchase more imported goods for every unit of export that it sells when its TOT improves. An
increase in the TOT can thus be beneficial because the country needs fewer exports to buy a given number of
imports.
It might also have a positive impact on domestic cost-push inflation when the TOT increases because the
increase is indicative of falling import prices to export prices. The country’s export volumes could fall to the
detriment of the balance of payments (BOP), however.
The country must export a greater number of units to purchase the same number of imports when its TOT
deteriorates. The Prebisch-Singer hypothesis states that some emerging markets and developing countries
have experienced declining TOTs because of a generalized decline in the price of commodities relative to the
price of manufactured goods.
TOT Example
Developing countries experienced increases in their terms of trade during the commodity price boom in the
early 2000s. They could buy more consumer goods from other countries when selling a certain quantity
of commodities, such as oil and copper.
In the past two decades, however, a rise in globalization has reduced the price of manufactured goods.
Industrialized countries' advantage over developing countries is becoming less significant.
Exchange Rate
An exchange rate is the value of one nation's currency versus the currency of another nation or economic
zone. For example, how many U.S. dollars does it take to buy one euro? As of September 24, 2021, the
exchange rate is 1.1720, meaning it takes $1.1720 to buy €1.
KEY TAKEAWAYS
 An exchange rate is the value of a country's currency vs. that of another country or economic zone.
 Most exchange rates are free-floating and will rise or fall based on supply and demand in the market.
 Some exchange rates are not free-floating and are pegged to the value of other currencies and may
have restrictions.
Understanding Exchange Rate
Typically, an exchange rate is quoted using an acronym for the national currency it represents. For example,
the acronym USD represents the U.S. dollar, while EUR represents the euro. To quote the currency pair for
the dollar and the euro, it would be EUR/USD. In the case of the Japanese yen, it's USD/JPY, or dollar to yen.
An exchange rate of 100 would mean that 1 dollar equals 100 yen.
Typically, exchange rates can be free-floating or fixed. A free-floating exchange rate rises and falls due to
changes in the foreign exchange market. A fixed exchange rate is pegged to the value of another currency. For
instance, the Hong Kong dollar is pegged to the U.S. dollar in a range of 7.75 to 7.85. 2  This means the value
of the Hong Kong dollar to the U.S. dollar will remain within this range. 
Exchange rates can have what is called a spot rate, or cash value, which is the current market value.
Alternatively, an exchange rate may have a forward value, which is based on expectations for the currency to
rise or fall versus its spot price. 
Forward rate values may fluctuate due to changes in expectations for future interest rates in one country
versus another. For example, let's say that traders have the view that the eurozone will ease monetary policy
versus the U.S. In this case, traders could buy the dollar versus the euro, resulting in the value of the euro
falling. 
Exchange rates can also be different for the same country. Some countries have restricted currencies, limiting
their exchange to within the countries' borders. In some cases, there is an onshore rate and an offshore rate.
Generally, a more favorable exchange rate can often be found within a country's border versus outside its
borders. Also, a restricted currency can have its value set by the government.
China is one major example of a country that has this rate structure. Additionally, China's yuan is a currency
that is controlled by the government. Every day, the Chinese government sets a midpoint value for the
currency, allowing the yuan to trade in a band of 2% from the midpoint.
Key term Definition
the price of one currency in
exchange rate terms of another currency; for
example, if the exchange rate for
the euro (€) is 132132132 yen
(¥), that means that each Euro
that is purchased will
cost 132132132 yen.
appreciate when a currency becomes
more valuable relative to another
currency; a currency appreciates
when you need more of another
currency to buy a single unit of a
currency.
depreciate when the value of a currency
decreases relative to another
currency; a currency depreciates
when you need less of another
currency to buy a single unit of a
currency.
floating exchange rates when the exchange rates of
currencies are determined in free
markets by the interaction of
supply and demand

FOREIGN DIRECT INVESTMENT (FDI)

A foreign direct investment (FDI) is a purchase of an interest in a company by a company or an investor
located outside its borders.
Generally, the term is used to describe a business decision to acquire a substantial stake in a foreign business
or to buy it outright in order to expand its operations to a new region. It is not usually used to describe a stock
investment in a foreign company.
 Foreign direct investments (FDI) are substantial investments made by a company into a foreign
concern.
 The investment may involve acquiring a source of materials, expanding a company's footprint, or
developing a multinational presence.
 As of 2020, the U.S. is second to China in attracting FDI.
How Foreign Direct Investments (FDI) Work
Companies considering a foreign direct investment generally look only at companies in open economies that
offer a skilled workforce and above-average growth prospects for the investor. Light government regulation
also tends to be prized.
Foreign direct investment frequently goes beyond capital investment. It may include the provision of
management, technology, and equipment as well.
A key feature of foreign direct investment is that it establishes effective control of the foreign business or at
least substantial influence over its decision-making.
In 2020, foreign direct investment tanked globally due to the COVID-19 pandemic, according to the United
Nations Conference on Trade and Development. The total $859 billion global investment compares with $1.5
trillion the previous year.1
And, China dislodged the U.S. in 2020 as the top draw for total investment, attracting $163 billion compared
to investment in the U.S. of $134 billion.
Types of Foreign Direct Investment
Foreign direct investments are commonly categorized as horizontal, vertical, or conglomerate.
 With a horizontal direct investment, a company establishes the same type of business operation in a
foreign country as it operates in its home country. A U.S.-based cell phone provider buying a chain of
phone stores in China is an example. 
 In a vertical investment, a business acquires a complementary business in another country. For
example, a U.S. manufacturer might acquire an interest in a foreign company that supplies it with the
raw materials it needs.
 In a conglomerate type of foreign direct investment, a company invests in a foreign business that is
unrelated to its core business. Since the investing company has no prior experience in the foreign
company's area of expertise, this often takes the form of a joint venture.
Examples of Foreign Direct Investments
Foreign direct investments may involve mergers, acquisitions, or partnerships in retail, services, logistics, or
manufacturing. They indicate a multinational strategy for company growth.
They also can run into regulatory concerns. U.S. company Nvidia has announced its acquisition of ARM, a
U.K.-based chip designer. In August 2020, the U.K.'s competition watchdog had announced an investigation
into whether the $40 billion deal would reduce competition in industries reliant on semiconductor chips.
What Is the Difference Between FDI and FPI?
Foreign portfolio investment (FPI) is the addition of international assets to the portfolio of a company, an
institutional investor such as a pension fund, or an individual investor. It is a form of portfolio diversification,
achieved by purchasing the stocks or bonds of a foreign company.