THE GLOBAL ECONOMY Many countries export a substantial portion of the goods and services

THE GLOBAL ECONOMY Many countries export a substantial portion of the goods and services

they produce. Looking at just the United States, we see in Exhibit 25.2 that the role of exports and imports in the economy is ever increasing. In panel (a), we see the imports and exports growing through time. In panel (b), we see the net trade balance (that is, exports less imports), which illustrates that the United States has maintained a negative trade balance (referred to as a “deficit”) for an extended period. The major exports of the United States are chemicals, computers, and consumer durable goods. The major imports of the United States are petroleum, automobiles, clothing, and computers. The top three trading partners of the United States in 2001, in terms of exports and imports, were Can- ada, Mexico, and Japan.

Countries trade with each other, exporting and importing, because it allows them to specialize. This ability to specialize makes for more efficient production and, ultimately, greater output. Countries will pro- duce and export goods and services for which they have a comparative or competitive advantage and countries will import goods and services for which other countries have a comparative or competitive advantage.

A comparative or competitive advantage may originate from a country’s natural resources (such as petroleum), its human resources (such as edu- cation), its capital investment (which may or may not be aided by the government), or its laws or regulations that may promote certain activi- ties. For example, the chief exports of the United States are machinery, transportation equipment (e.g., trucks and aircraft), chemicals, and grain products, which relate to the vast capital investment in the heavy industries (e.g., steel production) and the acreage devoted to farm prod- ucts. The chief import of the United States is petroleum because of the diminished U.S. oil reserves combined with the strong demand for fuel and petroleum-based products (e.g., plastics).

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EXHIBIT 25.2 United States’ Exports and Imports, 1919–2001 in Real Dollars

Panel a: Exports and Imports

Panel b: Net Trade Balance

Source: Federal Reserve Bank of St. Louis

SELECTED TOPICS IN FINANCIAL MANAGEMENT

Many advocate free trade, which is trading among countries with- out barriers such as export or import quotas and tariffs (taxes on imported goods). The benefits of free trade include enhanced competi- tion, which ultimately benefits the consumer. However, for countries for which there are few or no comparative or competitive advantages, free trade may not be beneficial, and such countries may impose barriers to protect their own companies. These barriers may affect foreign compa- nies’ investment and financing decisions in that country.

Throughout history, most countries have exercised some protection- ism. However, trends throughout the twentieth century reduced protec- tionism. One such agreement is the General Agreement on Tariffs and Trade (GATT), which was first signed by 23 countries in 1947. GATT is basically a forum for negotiating the reduction in trade barriers on a multilateral basis—that is, many countries agreeing to such reductions at one time. Through time, other nations joined in GATT.

Monetary cooperation is facilitated through the International Mone- tary Fund (IMF), an agency of the United Nations, which began opera- tions in 1947. The objective of the IMF is to promote monetary cooperation and encourage international trade. An important function of the IMF is to facilitate trade through a system of payments for current transactions. Further, the IMF strives to reduce and eliminate restrictions on foreign exchange. In 2001, there were 184 member nations of the IMF.

Two recent major agreements affect trade among major industrialized nations: the European Union and the North American Free Trade Agree- ment. The European Union (EU) is an organization, consisting in 1996 of

15 European countries, whose goal is to increase economic cooperation and integration among its member countries. The European Union was established with the Maastricht Treaty in November 1993, which was then ratified by the member nations, forming the European Economic Community (EEC). Under this treaty, citizens of the member countries gain mobility because immigration and customs requirements are reduced. An objective of this union was the development of a common currency for all member nations. The European countries that did not join the Euro- pean Union remained in its predecessor, the European Free Trade Associa- tion (EFTA), which was formed to reduce trade barriers and to enhance economic cooperation. A January 1994 agreement eliminated trade barri- ers between the EU and the EFTA by creating the European Economic Area, and creating the largest free trading area in the world.

The North American Free Trade Agreement (NAFTA) is a pact among Canada, Mexico, and the United States for the gradual removal of trade barriers for most goods produced and sold in North America. This pact became effective January 1, 1994, and makes North America the world’s second largest free trade zone. It is expected that this pact

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will expand to encompass Latin American countries, but the economic requirements imposed upon included countries may be difficult for some countries to satisfy, as least in the near term.

Most of the significant trade pacts involve major industrial nations. However, because many of the future growth opportunities are in lesser- developed nations, barriers to free trade exist and are important consid- erations in many aspects of financial decision making.