Infernal Ramblings
A Malaysian Perspective on Politics, Society and Economics

Monetary Benefits of Trade

Written by johnleemk on 1:49:17 pm Jun 9, 2007.

I am a strong advocate of free trade. Like many, I tend to think of the competitive advantages trade brings, and how it optimises the use of resources through comparative advantage.

However, there are other angles of approach to the issue of trade. One such approach was exemplified by the founder of the monetarist school of economics, Milton Friedman, when in response to a suggestion that free trade would lead to developing countries selling to developed nations without buying anything in return, he said something like "What are they going to do with dollars, eat them?"

When a country sells something to another country, that other country will pay in its domestic currency. There is no way of escaping this.

What happens after that? The exporting country is holding this currency, which for the sake of convenience we'll call dollars. What can it do with it?

There are only two things it can do: spend it in the importing country, or exchanging the currency with someone else who intends to carry out business transactions in dollars.

That is why, as Friedman pointed out, money sent overseas does not disappear into a black hole. It still ends up spent in the importing country. (Those with a basic knowledge of international economics would know that this is why the balance of payments is always zero for a country with a floating exchange rate.)

People are often hung up about trade surpluses and deficits, arguing that something must be wrong if their country is running a trade deficit with some other country.

However, this overlooks the basic fact that this deficit must be compensated for by a surplus somewhere else. If the other country is running a trade deficit with you, it must be either holding your currency in its reserves (which means it will spend it later, addressing the deficit) or must have traded your currency with another country which wants to buy from you (creating a trade surplus between you and that other country).

Moreover, focusing on the balance of trade alone ignores foreign investment in your country. Such investment is a direct injection of money into the economy, and often raises living standards (as any investment tends to do).

Of course, the economic nationalists will point out that in the long run, there will be an outflow of dividends from the country. But this easily overlooks the benefits of foreign investment, especially direct investment.

When foreigners are training your workers, building your infrastructure, you are basically getting something for nothing. Even if the foreign companies up and leave, they leave you a skilled workforce and ready-made infrastructure.

That's why there's something to be said for trade if you think about it logically and consistently. No matter how you look at it, in trade, the situation is win-win for everyone. After all, isn't that the point of trading?

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